Research & Development Credits (Section 41)
Corporations often view efforts to develop new products, improve legacy products, or enhance outdated and costly processes merely as a cost of doing business. As a result, these businesses may be overlooking a potential tax benefit.
The IRC Section 41 research tax credit was enacted as a provision of the Economic Recovery Tax Act of 1981 as a key component of a multi-faceted tax reduction package to ensure future economic growth. The credit is in addition to the tax deduction for research expenses and the benefit results in a dollar-for-dollar reduction of the business’ income tax liability.
What is qualified research?
Qualified research must:
- Involve activities aimed at the development of a new or improved product or process. This includes all technical activities such as analysis, design technical requirements, developing, coding, testing, etc. undertaken from initial design, proof of concept, planning and definition, architecture and detailed design, and development testing.
- Be intended to discover information that is “technical in nature” and useful in the development of a new or improved business product, process, computer software, technique, formula or invention.
- Rely upon a process of experimentation whose ultimate aim is the development of a business component with a “new or improved function, performance or reliability or quality.” These activities generally involve the evaluation of alternatives, trial and error, failures, or other testing methodologies. Examples of qualifying activities include developing new and improved legacy products, designing and testing preproduction prototypes and models, and developing software applications.
What expenses are eligible for the credit?
Expenses included in the credit computation are in-house salaries and wages of employees engaged in qualified research, as well as costs of materials, supplies and certain time-sharing costs for computer use in qualified research. In addition, 65% of amounts paid to third-party contractors for conducting qualified research are eligible for the credit.
In addition to the federal research credit, approximately 35 states have enacted some form of research credit. Research and development (R&D) activities may also enable a company to qualify for other incentives, such as investment credits, jobs credits, and sales and use tax exemptions.
Is your company a candidate for the research credit?
Any firm with leading edge technology is likely to have qualified research and eligible costs. Companies in the chemical, electronics, manufacturing, medical technology, pharmaceutical, and software industry sectors are candidates for the credit.
Check with your EisnerAmper tax professionals for details, including applicability to your company, exclusions and the R&D credit calculation.