In 1981, the R&D Tax Credit was added to the tax code as part of the Economic Recovery Tax Act. It has been renewed regularly and remains in effect through the current tax year. Over the intervening years, however, several changes and clarifications have been made to the original R&D Tax Credit. A four-part test is generally applied to R&D expenses to ensure that they qualify under this tax credit:
- The R&D expenditures must have been made for a permitted purpose, usually to improve existing products or to create new ones.
- A systematic process of experimentation must be followed to ensure the scientific validity of the results.
- There must be an intention to eliminate uncertainty regarding the method used to develop or improve current technologies.
- The R&D performed must be directed toward technological and scientific advances in the fields of engineering, computer science or the physical and biological sciences.
The expenditures allowable under the R&D tax credit include the wages of employees directly involved in the research work, the supplies used for R&D and applicable contract fees or research payments made to third parties in the course of the project.
The Alternative Simplified Credit
The Alternative Simplified Credit allows businesses to avoid extensive historical financial documentation required with other methods and provides an easier calculation algorithm. Companies can claim a credit of 14 percent of all qualified research expenses (QRE) that exceed 50 percent of the average QRE over the past three tax years. Businesses that do not have any QRE for the previous three years can claim 6 percent of their current QRE.
- For example, a food and beverage company that spent $600,000 in QREs during the last three years and has spent $300,000 this year in QRE can claim 14 percent of the amount over $100,000 for this tax year. This would amount to 14 percent of $200,000, which adds up to $28,000 in tax credits under the Alternative Simplified Credit.
- A comparable food and beverage company that spent nothing on QRE over the last three years but that spent $200,000 this year would receive a flat 6 percent of that amount under the Alternative Simplified Credit. This would add up to $12,000 in tax savings or refunds.
For some companies, calculating the full amount of QRE in the time allotted for tax filing can be challenging, especially given the four-part test requirements that must be met for these expenses. In some cases, the figures needed to determine the applicable expenses may not be available until after the tax deadline has already passed. As a result, many businesses have failed to take advantage of this tax credit and have missed out on considerable financial savings on their tax liabilities.
How These Changes Will Affect Business
The Internal Revenue Service (IRS) typically allows amended tax returns for up to three years after the filing date. By allowing the use of the Alternative Simplified Credit on amended tax returns, the IRS has essentially extended the time allowed for businesses to calculate and apply for this credit. This will allow more companies to qualify and take advantage of the savings offered by the Alternative Simplified Credit. The potential financial savings for these corporate enterprises can amount to thousands of dollars that can be used to further their research efforts or for core business activities.
Working with the professional CPAs and business advisors at Chortek can help businesses of all sizes to maximize their tax savings and can ensure the most advantageous financial position for these companies. With the recent changes to the Alternative Simplified Credit, Chortek clients can potentially realize significant benefits and added monetary resources with which to pursue their goals in the competitive marketplace.