Who Qualifies for the R&D Tax Credit?

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Who qualifies for the R&D tax credit depends on how individual companies choose to deduct capital expenses. According to the IRS, businesses may either deduct their R&D expenditures in the following tax year, or they are allowed up to 60 months to repay the expenses. Below expands on who qualifies for the tax credit and how to calculate R&D expenses.

An Introduction to R&D Tax Credits

The R&D tax credit is offered by the federal government, but every state also offers different levels of qualifying compensation. The R&D tax credit was designed to invigorate research and development activity within the US by reducing the after-tax costs of operating a business. Most companies that qualify for the credit are able to deduct up to 20 percent of eligible research expenses from their corporate income taxes.

The R&D tax credit was started in the 1980’s as part of the Economic Recovery Tax Act. The tax credit support was designed to help US companies maintain their technological competitiveness in the global marketplace. The R&D tax credit was originally only available for large corporate manufactures, but adjustments have been made in recent years to include small to medium sized businesses.

Who Benefits from the Tax Credit?

The R&D tax credit applies to business activities related to the design, development or optimization of products, processes and techniques. Research related to scientific formulas, software programs and business services also qualify. Benefits are calculated based on increases in research activities and expenses, so its intended to reward innovation and investments. Certain industries rely on the R&D tax credit to fuel their product expansion activities.

These include drug, food, textile and electronic manufacturing. It also covers aerospace, graphic design, cosmetic research and software development. Any of these industries can use the R&D tax credit to develop new models, prototypes or patents. The tax credit can also be used for product, certification and environmental testing. It can even be used to build new manufacturing facilities and streamlining internal business processes.

Qualified Research Expenses

Qualified Research Expenses (QREs) are defined in section 174 of the Internal Revenue Code (IRC). Eligible expenses are limited to internal wages and supplies that are attributed to qualified research, which may include costs of computer use. The tax credit also covers up to 65 percent of contractual research expenses conducted by foreign vendors. Almost all corporations use their financial accounting system to define and determine their R&D costs for tax purposes.

According to Cornell Law School, because IRC 174 is vague when it comes to the term research expenses, the IRS expects companies to provide comprehensive justifications of how they classify costs. However, section 41(d) does state that eligible expenses only apply to research that is undertaken to discover technological information or to activities that consist of experimental processes.

Related Resource: What is a Limited Liability Company?

Who qualifies for the R&D tax credit will depend the company’s research scopes and activities. In order to reduce the associated audit risks, companies should collect accounting documentation and submit it with their tax returns.

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