It’s one of the best-kept secrets of the entire Internal Revenue Service (IRS): the research and development (R&D) tax credit.
While many business owners and CPAs have simply never heard of the R&D tax credit, it is a cost-savings opportunity you don’t want to miss, especially because most companies vastly underestimate – or entirely ignore – their true amount of research and development.
Here are a few steps to get you started on maximizing the federal and state research and development tax credit for your business or CPA firm clients:
Ensure You Support The FIN 48 (ASC 740-10) Memorandum
In order to properly prepare and claim your R&D tax credits, your business or CPA client needs to ensure that the proper documentation in place that supports the FIN 48 requirements. FIN 48 (also known as ASC 740-10) is the official interpretation of U.S. generally accepted accounting principles (GAAP) that requires companies to analyze and disclose income tax risks based on relative probable outcomes for financial statement recognition and measurement of tax positions taken on a tax return.
For example, your business might be able to recognize a greater R&D tax credit benefit on your financial statements if your research and development has a high probability of being sustainable under audit with the proper documentation and substantiation in place. Without the proper documentation, companies are less likely to sustain their credits and will have to place a higher reserve on their R&D tax credits.Because the FIN 48 memorandum entails such complex analysis and preparation, it’s best to employ a professional tax consultancy who has experience and proficiency in the FIN 48 requirements.
Step 2: Track, Report And Calculate All Possible R&D Expenses
Keeping the FIN 48 criteria in mind, now it’s time to dive into which business activities and expenses qualify for the R&D tax credits. In general, your company qualifies for the R&D tax credit if you have invested time, money or resources into the creation or improvement of a product, process, technique, formula, invention or software application.
The following is just an introductory list of qualifying activities to consider:
- Conducting research or experimentation
- Developing new or improved concepts or hypotheses
- Developing or designing new products, processes or systems
- Significantly modifying or redesigning existing products, processes or systems
- Testing new materials and concepts
- Researching product or material alternatives
- Developing internal software solutions
- Designing or evaluating product alternatives
- Creating new design and/or functional specifications
- Designing, constructing, testing and evaluating prototypes
- Reviewing experimental results
- Developing new manufacturing processes
- Participating in technical meetings
- Documenting research activities
- Compiling research documentation and data
- Maintaining laboratory equipment
- Directly supporting or supervising research activities
- Using outside contractors to conduct research and development activities
Within these activities, the following research and development costs qualify for the R&D tax credit:
- Wages: Wages are only eligible for the R&D tax credit if the earnings are paid to an employee who performs a qualified R&D service (such as the activities listed above).
- Supplies: Supplies are any tangible property other than land, land improvements or other property subject to depreciation that is used or consumed during research. Supply expenses must be directly linked to qualified research activities, including prototypes and testing materials. Travel, shipping or royalty expenses cannot be included as supply expenses.
- Contract Research: Payments to third-party contractors qualify for the R&D tax credit at 65% of the actual expense as long as the contracted work meets the same qualifications as the wage expenses listed above. However, for this expenditure to count towards the tax credit, your business must have some rights to the research results and you must take on the risk of development.
Claiming the research and development tax credit isn’t always an easy process for your business to navigate. However, when you pinpoint and document each of your research and development expenses and file your claim correctly, the resulting tax credit – and revenue increase – is well worth the effort.
Get more insight on the research and development tax credit. Download our guide and discover how to turn this confusing tax credit into a benefit to your bottom line.
