The topic of Research and Development (R&D) is often associated with images of scientists gathered around a table to discuss complex formulas and space-age discoveries. But did you know that if your company’s staff employs personnel such as software developers, engineers, and machinists, your R&D expenses could qualify for tax credits?
Many companies fail to take advantage of this tax credit, unaware that they have qualifying R&D expenses that are approved by the IRS. These do not have to be pioneering inventions or innovative undertakings. Rather, this credit is available to companies that create or improve products and trade processes.
IRS Criteria for R&D Credits
The federal R&D tax statute provides a credit of up to 10% of qualifying expenses. However, many states also have this credit which can bring the total percentage to as high as 20%. Rules for determining what qualifies as R&D expenses are listed under Internal Revenue Service Code section 41.
The IRS has a predefined set of criteria that determines what activities satisfy the requirements of qualifying R&D expenses. These are as follows:
- The activity must have a purpose such as improvements in function, performance, reliability, or quality. Projects related to the appearance of a product do not qualify.
- Technical uncertainty related to the capability, methodology, or design of the business. The uncertainty must be attempted to be resolved with experimentation. This does not include any economic uncertainties.
- The project must rely on hard science such as engineering, physical/biological sciences, or computer science.
Once all the above criteria are met, then related expenses in wages, supplies, and contract research that were incurred during the project can be considered qualified R&D expenses.
Technology R&D Expenses
According to Accounting Today, here are some of the most commonly overlooked technology expenses that can qualify as R&D expenses:
- Cloud-Computing Costs
Many companies have harnessed the power of cloud computing which provides an efficient way of storing, processing, and analyzing data. The server, platform, and Software as a Service (SaaS) technology costs included in cloud computing may fall under qualified research expenses (QREs) for both federal and state R&D credits. Development platforms and beta-testing of software are also included in this classification.
- Migration Of System Platforms
The complex project of migrating systems to the cloud often involves technical uncertainty and failure, qualifying it as an R&D expense.
- Replacement Of Obsolete Parts
Should a part from a product become obsolete, redesigning and testing are necessary for a replacement. This process involves technical uncertainty and failures which can be considered R&D expenses. Expenses can include wages of engineers and other associates involved in the redesigning process so long as their contributions are clearly demonstrated.
- Automation Expenses
Technology that is developed to improve the efficiency of the manufacturing process is considered a QRE. Robotic components are a good example of this as uncertainty exists as to where to place them and what they will do. The cost of the robot itself cannot be included, but the research into where and how they will fit into the process as well as the testing are qualified expenses.
- Artificial Intelligence and Machine Learning
Artificial intelligence and machine learning are used to improve manufacturing efficiencies. As a result, the research expenses involved in these aspects would also qualify as QREs.
Other Industries Eligible For R&D Credits
There are many other industries and applications where qualifying R&D expenses can be claimed. The CPA Journal lists several of these in various areas.
Restaurants, for example, may have qualifying expenses such as ways to improve nutrition, safety, and preservation of food. The construction industry involves designing new heating and air conditioning systems as well as new construction techniques. Agriculture involves researching and designing new irrigation systems, harvesting improvements, and new feeding techniques for livestock.
Many taxpaying companies can benefit tremendously from the R&D tax credit. However, millions of dollars go unclaimed yearly since businesses fail to recognize exactly what qualifies for this credit.
Incentax can help identify and maximize qualifying R&D expenses for your business. Contact us for more information on how you can take advantage of these tax credits.