When to Use Research and Development Tax Credits

The federal Research and Development Tax Credit – also called the Research Tax Credit or the Research and Experimentation Tax Credit – is a dollar-for-dollar, wage-based tax reduction that rewards companies for investing in qualified research activities. It could mean thousands of dollars for your business and remains intact for 2018, despite the recent tax reform.
Contrary to popular belief, the research tax credit is not just for technology and pharmaceutical companies. It can also be used by qualifying manufacturers, engineers, architects, and other types of businesses. Please note: In addition to federal tax credits, individual states may offer similar incentives. Check with your state government to find out.
Does your business qualify for research and development tax credits? It may if you engage in one of these activities:
  • Design new products
  • Improve existing products
  • Improve manufacturing processes through technology
  • Develop new formulas or techniques
  • Improve customer part designs to improve manufacturability
  • Design tools, fixtures, molds, or dies
  • Develop prototypes or models (including computer generated models)
  • Apply for patents
  • Test new concepts or technology
  • Implement robotics or production control software
  • Streamline or improve production or manufacturing processes to achieve higher standards in quality and productivity
  • Perform certification testing
  • Expend resources on outside consultants or contractors to conduct any of the above-stated activities
If you meet one of the above criteria, you must also meet all four of these basic requirements:
  1. Meet the definition of qualified research activities. Qualified research activities are defined as “the development or improvement to a business component, which is defined as a product, process, technique, formula, invention or software.”
  2. The research must be technological. That is, your experimentation process relies on the physical or biological sciences, engineering, or computer science technologies.
  3. Eliminate uncertainty. Your research must eliminate uncertainty in the development or improvement of a business component.
  4. Need of experimentation process. You must eliminate technical uncertainty through a process of experimentation, including systematic trial and error, modeling or simulation.

Game Plan

A good first step is to look at professional associations for your industry. They may have information that can help you understand how the credit could apply to your company. Then, review sections of IRS Publication 535, and Form 6765 with your tax professional. In addition, search for these credits on your state’s taxation website.
Before you apply, you’ll need to have records and detailed information in order. You may need a project-based or cost center accounting system. Compile the following information on the nature of our research:
  • Marketing materials
  • Bid packages
  • Patent applications
  • Management reports
  • Engineering drawings
Also, to fully understand the benefit of the research and development tax credit, debunking the common myths surrounding it is a good starting point.
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