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SMART TAX USA - Research and Development Tax Credits

Research and Development Tax Credits

The Research and Development Tax Credit has been included in Section 41 of the Internal Revenue Code ever since it was created by Congress in 1981 as part of the Economic Recovery Tax Act. The purpose of the tax credit is to stimulate the American economy by encouraging businesses to invest in research and development of new and improved products. Congress has acted to extend the research and development tax credit and many states also have their own R&D tax credits. Large corporations that take full advantage of research and development tax credits can create budgetary savings of more than $100,000 per year.

Calculating the correct amount for research and development tax credits can be complicated. The Internal Revenue Service provides two different methods. Companies can either use the regular research credit method or the alternative simplified credit method. According to the regular research credit method, the tax credit equals 20% of qualified research expenditures in excess of a base amount established by the taxpayer during the years between 1984 and 1988. Using this method of calculation may work best for companies that can document a relatively low base amount. With the alternative simplified credit method, the tax credit equals 14% of the average qualified research expenditures in any one tax year that exceeds 50% of the average qualified research expenditures from the immediately preceding three years. Using this method of calculation works best for companies that were not in existence between 1984 and 1988 or had a high base amount established during that time period. If a taxpayer had no average qualified research expenditures during the immediately preceding three years, the alternative simplified tax credit may be 6% of the tax year's average qualified research expenditures.

The types of businesses most likely to benefit from research and development tax credits include manufacturers, fabricators, pharmaceutical and biotechnology companies, food processers, engineering companies and software developers. Benefits to businesses include millions of dollars in tax credits, refunds from previous years if tax credits were appropriate but not claimed, and additional tax savings in future years with the potential to carry forward already claimed tax credits for up to 20 years.

SMART TAX USA has helped many large corporations save money by taking full advantage of all available research and development tax credits. As required by the Internal Revenue Service, we utilize the Comprehensive Project by Project Approach to analyze annual budgetary expenditures and identify the items that qualify for research and development tax credits. The first step is to determine whether expenditures are acceptable in accordance with the Internal Revenue Service’s general criteria for research and development:

Permitted purpose - Research and development must result in a new or improved process, function, product, performance, reliability, quality or significant reduction in cost.

Elimination of Uncertainty - Research and development activities may be acceptable for a tax credit if they are intended to eliminate uncertainty in the development or improvement of a product.

Technical in Nature - If research and development relies on the principals of either engineering science, physical science, biological science or computer science, it may be eligible for a tax credit.

Process of Experimentation - Research and development activities may be acceptable for a tax credit if they involve one or more hypotheses for specific design decisions, lead to testing, refining and analyzing of the hypotheses, or even lead to eventually discarding the hypotheses.

The Internal Revenue Service has raised the research and development tax credit to a Tier 1 audit item issue. Because the responsibility for establishing the qualifications for tax credits belongs to the taxpayer, companies need to be prepared with adequate documentation of all research and development expenditures including information indicating why expenditures qualify for a tax credit. At SMART TAX USA, we provide a free research and development tax audit defense as part of our service if a defense needs to be conducted.

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