The R&D tax credit: Are you getting the credit you deserve?
The federal Research and Development (R&D) tax credit has been around since 1981 and approximately $7 billion in R&D credits are awarded to companies annually.
Despite this, most small and medium sized manufacturing companies fail to claim the credit or claim far less credit than they are eligible to receive. Further, many manufacturing companies are not aware that recent tax law changes have made the R&D credit easier to claim, and many more activities now qualify for the credit. Many non-manufacturing companies can also qualify for the credit, such as technology development companies.
The R&D credit calculation can be quite complicated; however, it is generally calculated as 20 percent of "research" expenses, subject to certain limitations for previous years. "Research" expenses generally include labor, material, supply and outsourcing costs. Activities which usually qualify as "research" include: New product development, product improvements, process improvement, patent application cost, testing new materials, new technology and many other areas ("new" meaning new to your company, not new to the world).
A New Playing Field
Historically, the credit was limited to companies conducting activities of a "white-coat" scientific nature or companies developing products unique to the world. In the past few years, IRS regulations have significantly relaxed the requirements. These more generous regulations have opened up the possibility for many more companies to claim the R&D credit. I believe almost all manufacturing companies are doing some activities that qualify for the R&D credit under the new regulations. In addition, these new regulations can be applied retroactively to amend three to four years of prior year tax returns to claim tax refunds for those years. These claims can generate very large cash refunds.
A Double Dip
Just like other business expenditures, R&D costs for labor, supplies, material and other items are generally directly expensed on a business tax return. The beauty of the R&D credit is that, in addition to the normal write-off of these expenditures, a business is allowed a portion of these expenses as a further tax credit to reduce income tax due. It's almost like a double benefit; the taxpayer gets to take an ordinary business expense deduction, plus they get an additional tax credit for a portion of the expenditures.
The federal R&D credit is currently expired, however it is expected that congress will reinstate it before the end of 2006 or early in 2007. Companies that are currently taking advantage of the R&D tax credit should make sure they are taking the maximum credit as allowed under the new IRS regulations. If you are a manufacturing or technology company and not taking any R&D tax credits, you should look into the opportunity. The credit rules and calculations can be somewhat complicated, but the benefits can be substantial. An unclaimed credit is like leaving money on the table.
Mike Novik is a manager with the CPA firm, Dennis, Gartland, Niergarth. He is the leader of the firm's manufacturing and distribution services team and he works extensively helping the firm's manufacturing clients become more profitable. He can be reached at 946-1722. BN