Research expenses in science and technology qualify for a federal R&D tax credit. Improving your products or developing new ones may enable you to take advantage of this tax incentive. If more than 50% of your qualifying R&D activities occur at a particular location, you can apportion a percentage of R&D to that location.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 and The Tax Cuts and Jobs Act of 2017 (TCJA) have made it easier for businesses that develop innovative products and services to qualify for the tax credit. You can either claim the R&D tax credit or deduct your qualified expenses under IRC Section 174. Note that exploration expenditures don’t qualify as Section 174 expenses.
1. RESEARCH WAGES
Employee wages directly tied to R&D activities are the main expenses you can claim. They include wages for:
• Employees who perform qualifying research activities, such as scientists who conduct lab experiments or engineers who construct pre-product prototypes. These are the people who directly perform the main qualifying research activities.
• Employees who perform direct supervision like first-line managers or supervisors
• Employees who offer direct support in administrative services such as clerks, security personnel, and training staff
The staff associated with the qualifying expense must have an employment contract with the company. They should not be self-employed or operate as a private contractor. The costs associated with employee wages that you can claim include:
• Gross wages
• Employer’s NI (National Insurance) contribution
• Pension expenses, accident reimbursement expenses, and travel expenses associated with R&D projects
Wages must be paid within the accounting period and should be paid before submitting the claim. The tax credit you receive will be based on the time your employees worked on the R&D project.
This is because employees are unlikely to spend all of their time on R&D activities. They will also perform other non R&D duties. Records like timesheets are used to determine the time an employee spends on an R&D project.
2. RESEARCH SUPPLY
Supply expenses are associated with the materials consumed when carrying out R&D activities. Examples include costs related to the use of chemicals during the testing process. Supplies pertaining to prototype testing, perfecting a patent application, or testing for product alternatives can also be included.
The utility costs (electricity, water, fuel, and gas) you incur in carrying out an R&D project can be claimed as a qualifying expense. The utilities must be used directly in R&D activities, however. You can also include the expenses that are incurred in running machinery or equipment for performing R&D activities. Note that expenses like rent can’t be included in the utility expense.
The software that is used directly in R&D activities is a qualifying expense. This can be standard software like Microsoft Word or Excel. It can also be dedicated software that is custom-made for a specific R&D project.
3. RESEARCH CONTRACT
Research contract expenses are costs incurred as a result of R&D activities carried out by a private contractor or organization that’s not affiliated with your company.
For the contract expense to qualify for the R&D tax incentive, the contracted work must take place in the United States. An agreement must also be drafted before performing the qualifying research.
The contracted research is 65 percent of the expenses you incur. Examples of these expenses include an engineering consultant’s fee, a subcontractor’s fee for generating prototypes, or lab fees for performing tests. A written agreement between the taxpayer and the contractor is required for the contract expense to qualify.
It is essential to know the expenses that qualify for the federal R&D tax credit and the ones that don’t qualify so that you can take full advantage of the tax incentive.
You can use the R&D tax credit to offset costs when conducting research to solve real-world challenges. At Incentax LLC, we offer a diverse range of tax credit opportunities that benefit companies in various fields and industries. Contact us to find out how you can lower your overall tax rate as you develop innovations that benefit society.