Which Industries Benefit The Most From the R&D Tax Credit?

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Tax credits for research and development encourage innovation and refinement, but which industries benefit the most from the R&D tax credit? Some businesses that formerly didn’t claim the credit are able to benefit from it after the bill passed in 2015 made it permanent. To understand the question, you first must understand what the R&D credit is.

Describing the Credit

In 1981, the Economic Recovery Act introduced the credit. Since that time, it has been extended 15 times. Finally, in 2015, it was made permanent. At that time, some modifications made it possible for medium-sized business to qualify for the benefit. Essentially, this is a tax credit, not a deduction, that allow industries to claim up to 14 percent of their qualifying expenses for research and development as a credit against their taxes.  The research must be performed to “eliminate uncertainty” between alternatives that could “create new, or improve existing, functionality, performance, reliability, or quality of a business component.” Research must employ engineering, physical, biological or computer science and a systematic approach. Some of the exclusions include research that begins after a product is already offered for commercial; production, adaptations of previously existing components, duplication and reverse engineering, surveys or studies and market research.

How the Benefit Works

Industries use the figures from three prior years to arrive at a mean R&D expense. They then take 50 percent of that amount as their tax base figure. The credit is calculated by multiplying that base by 14 percent. Obviously, the corporations with the highest gross earnings will have the greatest R&D expenditures and will get the largest credits. Changes made to the law when it was made permanent in 2015 allow smaller corporations to claim the credit against the AMT, or Alternative Minimum Tax. Previously, it was an “either-or” situation where smaller businesses didn’t benefit from the credit because they typically used the AMT because it was less complex.

Industries that Use the Credit

One “rule of thumb” is if your business has an engineer on-staff, you should take the credit. There are a number of industries that traditionally use the R&D credit. These are: manufacturers and fabricators; engineering houses; software developers; architectural firms; pharmaceutical companies; machinery developers; aerospace and defense corporations; die casting and tool manufacturers; foundries; automotive corporations and chemical companies. The larger the investment in R&D, the greater your recovery. Intel is a monster corporation that has learned to use the credit effectively; each year it modifies one or two things that are “critically important” to the speed and efficiency of their microprocessors.

The Tax Point Advisor points out that two changes in the law benefit other industries. One provision deals with the development of new products. That makes players out of agriculture and food processors. For instance, if a company develops a way to take the oil from a food resulting in a leaner, healthier product, they can claim the credit. The second change in the law says that you can claim the R&D expenses related to building a prototype, even if you later sell the prototype as a production model. This benefits industries like aerospace and automotive companies. There are still many “bugs” to work out.

Problems with the Law

Predicting which industries will benefit the most from the credit depends upon the government refining its terminology and eliminating conflicts. There are cases before the courts currently that seek to clarify some confusion in how the law defines some qualifications. For instance, Lockheed Martin is in litigation to decide whether it can claim a rocket launcher it developed as a prototype and then later sold as a commercial venture. The idea of what defines a prototype is in contention.

Related Resource: Sole Proprietor of a Business

As the law is modified in the next few tears, the R&D credit will become increasingly available to small and medium-sized businesses as well as huge corporations. That “coming-of-age” of the R&D credit will change which industries benefit the most.

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