| Share

R&D Cash for Clients

California CPA: March/April 2011

Recent changes have opened R&D tax credit to more businesses.

By Smith Miller, CEO, Chris Mann CPA, and John Urrutia, CPA

In these tough economic times, businesses need all the help they can get to be profitable. An often-overlooked source of revenue is the research and development tax credit, which encourages U.S. businesses to invest in improvements that increase their competitive position in the market. Along with providing an immediate source of cash, R&D tax credits can reduce current and future years’ federal and state tax liabilities.

Changes made to the credit in the past decade have removed the discovery test and documentation technical requirements, which has made the
credit available to small- and medium-sized businesses.

In addition to the federal credit, many states—including California—offer R&D tax credit incentives, which generally conform to federal guidelines. The credit can provide a reduction to past, current and future federal and state tax liabilities.

It differs from a deduction in that it is an actual dollar-for-dollar offset against taxes owed or paid.

The credit is a source of permanent tax savings and can be claimed for all open tax years. If the credits cannot be used in a particular year, they are carried back one year and then carried forward up to 20 years for federal credits, and indefinitely for California credits. Qualifying companies can retroactively claim R&D tax credits.

The credit is applicable when a new business component is developed or an existing business component is improved. Generally, a business component can be a product or a process and can include such things as:

Introducing new or improved products, processes or technologies.
Manufacturing products.
Developing prototypes or models (including computer generated models)
Designing tools, jigs, molds and dies.
Developing or applying for patents.

Advantages of the R&D tax credit include:

It allows businesses access to an immediate source of significant cash for funding growth by monetizing R&D expenses.
It can lead to permanent tax savings and is a vehicle to achieve additional tax savings in the future.
It allows a reduction to the overall effective tax rate and an increase in cash flow and earnings.

A list of industries that qualify for the credit is available online.

The credit is derived from qualifying expenses in three major categories:

Salaries and wages calculated and estimated as a percentage of employees’ qualifying time and can include those performing the qualified activity, those supervising the activity and those supporting the activity;
Supply costs consumed or destroyed during the qualifying activities; and
Contractor fees, where the rules are similar to salaries and wages.

Patents are one of the best documents to support the application of R&D credits. Other documents include: Advanced testing documents or images, contract review, engineering notes or sketches, lists or logs detailing innovation and/or new products, meeting minutes, new product development, process improvement discussions, project time records and schematics.

There are four statutory criteria to qualify for an R&D tax credit:

The first is the permitted process. The activity must relate to a new or improved product or process intended to improve function, performance, reliability or quality.
The second criterion is the technological nature of the activity, which must fundamentally rely on the principles of physical, biological or computer science, or engineering.
The third criterion is the elimination of uncertainty. The activity must be intended to discover information to eliminate uncertainty related to capability of a product or process, method of a product or process or appropriateness of a product design.
The final criterion is a process of experimentation. Substantially all of the activities must relate to a process of experimentation involving evaluating alternatives, confirming the hypotheses through trial and error, testing and/or modeling, or refining or discarding of the hypothesis.

R&D tax credits are no longer for large companies in the technology sector. Each year thousands of small- and medium-sized businesses benefit from the credits
for a wide range of activities that improve their competitiveness.

Smith Miller, CEO, Chris Mann, CPA and John Urrutia, CPA are with Strategic Tax Solutions. You can reach them at (916) 724-3974 or via their website.