Companies working on innovative and experimental research & development projects can qualify for the Federal and Virginia Research and Development (R&D) Credit and receive tax breaks, no matter how large or small the company.
This comes after the R&D tax credit was made permanent by the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) in December 2015. The new regulation has helped open doors for R&D tax credits for small startup companies as well as companies subject to the Alternative Minimum Tax (AMT).
Companies that historically did not qualify for R&D tax credits now have an opportunity to receive tax benefits starting January 1, 2016.
So what is the credit? And how can companies determine if they qualify?
The R&D tax credit is a business tax credit for companies that focus on innovation and experimentation. To determine if the company’s activity or project qualify as R&D a four-part test must be met:
|Permitted Purpose||The purpose of the activity or project must relate to a new (or improving an existing) functionality, performance, quality, reliability or manufacturability of any product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.|
|Elimination of Uncertainty||The taxpayer must intend to discover information to eliminate uncertainty concerning the development or improvement of a business component. Uncertainty exists if the current information available to the taxpayer does not establish the capability or method of development or improvement, or the appropriateness of the business component’s design.|
|Process of Experimentation||The taxpayers activities must substantially all be elements of a process of experimentation, which involves evaluation of alternatives, confirmation of hypotheses through trial & error process, testing and/or modeling, as well as refining or discarding of the hypotheses.|
|Technological in Nature||The process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and rely on existing principles of physical or biological sciences, engineering, or computer science to satisfy this requirement.|
Qualified research expenses of the activity or project include four types of expenses.
- Wages for in-house research and development activities of employees who directly conduct the research and development and employees who supervise and support the qualified research and development.
- Supplies such as prototypes and testing materials that are of a non-depreciable nature and are directly used and consumed in qualified research activities.
- Contracted research from a third party that does not bear the risk of success or failure in the research activities. Qualified research expenses are generally 65 percent of the contracted payments.
With the introduction of the PATH Act, there are more opportunities available for small and medium-sized businesses to claim this credit.
Previously, companies that did not generate enough income to have a federal income tax liability only had the option to carryforward the credit for future utilization. Beginning in 2016, eligible startup companies with less than $5 million in gross receipts can apply up to $250,000 of their R&D tax credit against the employer’s share of FICA payroll tax.
The PATH Act also brought great news for owners of qualifying pass-through entities, such as S Corporations and Partnerships, that incur Alternative Minimum Tax (AMT). Prior to the PATH Act the R&D tax credit did not offset the AMT liability. Beginning in 2016, owners of companies with less than $50 million in gross receipts (based on a three-year average) can apply the R&D tax credit generated after January 1, 2016 against their AMT liabilities.
In addition to the federal R&D credit Virginia has a similar credit available. Unlike the federal credit the Virginia credit is refundable for qualifying taxpayers, meaning the credit utilized can exceed the tax incurred and result in a refund.
If your company is in the industries of (not limited to) manufacturing, energy production, software development, food and beverage, distribution, construction or engineering and is innovating, improving its process, working on prototypes or experimenting there is an opportunity to receive the benefit of the R&D tax credit on a federal and state level. PBMares’ R&D tax credit specialists understand the nuances of the complex rules for qualification and have years of experience developing supportable tax credit claims. We can help you maximize your R&D tax credit which also maximizes your investment in the future of your business. Contact PBMares today to find out how!
About the Author
Nicholas Perrine, CPA is a tax partner with PBMares, LLP a leading accounting and business consulting firm serving U.S. and international clients with offices in the Mid-Atlantic. He helps clients pursue and receive federal and Virginia researching and development tax credits while helping expand the research and development tax credit group. He is a licensed CPA in Virginia and has a Bachelor’s of Business Administration Degree in Accounting from James Madison University. Nick can be reached at firstname.lastname@example.org and (540) 434-5975.