Research and Development Tax credits are often overlooked and misinterpreted by many small and mid-size businesses, too include their accountants' understanding of the credit, and why many businesses continue to miss out on a very valuable influx of cash refunds year after year after...
No the Research and Development Tax Credit is not available to only those that have on-site laboratories or have developed breakthrough research to claim such credits. Many business owners in nearly every industry are unaware that the research and development tax credit exists to reward day-to-day efforts aimed at producing and improving their products and/or services.
Before jumping into an applied example of the research and development tax credit let's first understand quickly the language of the code and what "R&D really means as it relates to qualifying activity.
Internal Revenue Code 41 known as the Research & Experimentation Tax Credit or the R&D Tax Credit is a general business tax credit for companies that are incurring R&D expenses in the United States. The R&D Tax Credit was originally introduced in the Economic Recovery Tax Act of 1981 sponsored by U.S. Representative Jack Kemp and U.S. Senator William Roth. Since the credit's original expiration date of December 31, 1985, the credit has expired eight times and has been extended thirteen times. The current extension is set to expire December 31, 2011.
Generally, qualified research is an activity or project undertaken by a taxpayer (directly or through direct funding of a third party on the taxpayers behalf) that comprises each of the four distinct elements:
Permitted Purpose: The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component. A business component is defined as any product, process, technique, invention, formula, or computer software (see exclusion for internal use software below) that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer's trade or business.
Elimination of Uncertainty - the taxpayer must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development or improvement, or the appropriateness of the business component's design.
Process of Experimentation: the taxpayer must undergo a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer's research activities. Treasury Regulations define this as broadly as conventional implementation of the scientific method to something as informal a systematic trial and error process.
Technological in Nature: the process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement.