Research and Development Credit – The Basics

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As an incentive for businesses to engage in research and development, the Internal Revenue Code provides for the Incremental Research Expenses Credit, also known as the Research and Development Credit (R&D Credit).  This credit may be claimed by a business as one of the general business credits. This credit is intended to benefit those who spend resources on bettering their technology with the intention to develop or improve a business component – especially in the manufacturing and distribution field. The expenditures must have a functional purpose.  They must relate to new or improved function or increase performance, reliability or quality.

The Research and Development Credit may be calculated using one of two methods. Under the general method, 20% of the increases in qualified research expenses over a base year are allowed as a credit against tax. The base period amount is a result of fixed-base percentage and average annual gross receipts for four years preceding the credit. The fixed-base percentage of qualified research expenses may not exceed 16% of gross receipts for the preceding four years. The base amount may not be less than 50% of the qualified research expenses for the credit year.

The Alternative Simplified Credit Method may also be used to calculate the increased research activities credit. Under the Alternative Simplified Credit Method, the credit is generally calculated as 14% of the amount of current year qualifying expenses in excess of 50% of the average of qualifying expenses over the three years preceding.

Expenses qualifying for the Research and Development Credit are generally all in-house expenses dedicated directly for research – wages, supplies, rent of a qualified facility and computer charges, as well as 65% of amounts paid or incurred for research done by someone other than an employee, or 75% if using a qualified research consortium.

The credit is subject to general business credit tax liability limitation and carryover rules. Additionally, the amount of credit will also reduce the deduction for research expenses unless otherwise elected.

Generally, it is preferential to take the credit and lower the corresponding deduction because there is a dollar for dollar tax benefit for expenditures resulting in a credit, as compared to a partial tax benefit for expenses treated as a tax deduction.

This information is intended to provide a basic understanding of the R&D Credit.  Please contact our office to better understand the details, and to explore taking advantage of this great credit.

Author: Sid Siddiqui

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