The federal government and many states provide tax credits to encourage innovation and job creation. Congress intended to incentivize an increase in research spending beyond what a company would otherwise spend with the Regular Credit (or “Traditional Credit”) in IRC §41 and Research and Experimental Expenditures methodology under IRC §174. The Alternative Simplified Credit (ASC) was introduced in Regulation Section 41(c)(5) to incentivize an increase in spending and keep research-intensive costs in the U.S. for multinational corporations.
The Impact of Tax Reform
The Protecting Americans from Tax Hikes (“PATH”) Act of 2015:
- Made R&D Tax Credit permanent effective January 1, 2016.
- Allows non-public companies with less than $50 million in gross receipts to offset the R&D credit against their AMT and regular tax liability.
- Also allows Qualified Small Businesses (QSBs), defined as small businesses with less than $5 million in gross receipts, to offset the R&D credit against FICA payroll taxes of up to $250,000 per year, for up to five years. To qualify a small business has to have: 1) gross receipts of less than $5 million for the credit claiming year, and 2) no gross receipts for any tax year preceding the five-year tax period ending with that tax year.
In order for research to qualify for the R&D Tax Credit, taxpayers must have undertaken projects and activities that meet the following four criteria under IRC §41 and IRC §174:
- Permitted Purpose: The activity must relate to a new or improved product or process intended to improve function, performance, reliability, or quality.
- Technological in Nature: The development activity must involve research that relies on the principles of physical science, biological sciences, engineering, computer science, etc.
- Eliminate Uncertainty: The activity must be intended to discover information to eliminate uncertainty related to capability of a product or process, method of a product or process, or appropriateness of a product design.
- Process of Experimentation: Substantially all of the activities must relate to a process of experimentation involving evaluation of alternatives; confirmation of hypotheses through trial and error, testing and/or modeling; or refining or discarding of the hypotheses.
Research and Development Tax Credit Categories
|Credit||Rate||§ 280C (35% rate reduction)||Minimum Base||Max|
(Elective on 6765)
|20%||13%||50% of Qualified Research Expenditures (QREs)||6.5%|
(Elective on 6765)
(4.55% if consistent QREs)
|Basic Research Credit||20%||13%||Complex formula — assumed at 50% of BRE||6.5%|
|Energy Research Consortium||20%||13%||N/A||13%|
(Elective on 6765)
|For QSBs, up to $250,000 per year, for up to five years|
ASC v. Traditional Research Credit
|ASC||Regular Research Credit|
|Effective Credit Rate||14% (9.1%)||20% (6.5%)|
|Base Amount||50% of the average QREs in the three years prior to the credit year||Indexed to Gross Receipts (GRs):
fixed base % (ratio of QREs/GRs in 1984–1988) x average GRs in the four years prior to credit year
|Minimum Base Amount||N/A||50% of credit year QREs|
|Maximum Base Percentage||N/A||Fixed base % cannot
|Considerations||Can be filed on initial and amended tax returns||Substantiating base is needed, requiring gross receipts and consistency|
STS tailors its approach to each client depending on the amount of potential credit, the eligible activities, and numerous other factors. The process generally includes:
- Evaluating activities by talking with and interviewing technical personnel
- Reviewing technical support documentation
- Determining activity costs to calculate Qualified Research Expenditure (QREs)
- Completing calculations
- Preparing a comprehensive report
Specialty Tax Solutions and Miller Cooper
Specialty Tax Solutions, LLC is a wholly owned subsidiary of Miller Cooper. Miller Cooper is one of Chicago’s premier independent firms of certified public accountants and business consultants. The firm has 320+ professionals practicing in accounting services, tax services, due diligence, forensic accounting and litigation support to highlight a few areas of expertise. Miller Cooper is a Chicago institution. The firm was founded in 1919, and has grown steadily over the years. Currently it is the 11th largest accounting firm in the Chicago area according to Crain’s Chicago Business. Miller Cooper is a dynamic, growth-oriented company that has significantly increased in size in the last 10 years as a result of its commitment to excellence for clients.
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For more information, please contact Norbert Crabtree at 864-593-6131 NCrabtree@mcclsts.com.