Article Published: October 28, 2014
Article Published: October 28, 2014
By Omar Thrower, Tax Manager, Louis Plung & Company
While the concept of the Research and Development (R&D) tax credit is not new, recent changes in tax law warrant a second look at the popular tax credit that could now apply to thousands of new manufacturers.
The R&D tax credit was adopted in 1981 and provides qualified taxpayers with a credit on expenses paid or incurred for qualified research. ‘Qualified research’ generally means research that is technological in nature and intended for the development of new or improved business components. The list of applicable industries is vast, and includes high-tech, software, agriculture, engineering, construction, oil and gas, and many more … and of course, manufacturing.
Issue at Hand: Method of Calculation
There are two methods available for calculating this credit. Beginning with tax years ending after December 31, 2006, there is the Regular Credit method and the Alternative Simplified Credit (ASC).
Depending on a taxpayer’s specific facts, the tax benefit could be more advantageous under the Regular method one year and the Alternative Simplified method the next year. Taxpayers are permitted to switch methods from year to year; however, once the ASC method is elected for a particular year, amending for the Regular Credit is not permitted.
Calculating the Credit
The Regular Credit’s value is equal to 20 percent of the excess of qualified research expenses for the current tax year over the average annual gross receipts for the four preceding years, multiplied by a fixed base percentage. The ASC value is 14 percent of the excess of qualified research expenses for the current tax year over 50 percent of the average research expenditures for the last three tax years. Under both methods, taxpayers have the option to elect a reduced credit under Section 280C, which means they are still permitted to take the deduction for qualified expenses.
Company A has $1.5 million in qualified research expenditures in 2013. Average gross receipts over the last four years are $8 million, and research expenditures for 2010, 2011, and 2012 were $990,000, $1.1 million, and $1.25 million, respectively. Assume the maximum fixed base percentage of 16 percent.
Average annual gross receipts: $8,000,000
Fixed base percentage of 16% = $1,280,000
Excess of research expenses = $220,000 ($1,500,000 - $1,280,000)
Multiplied by 20% = $44,000 credit
Alternative Simplified Credit
2010 Research expenses: $990,000
2011 Research expenses:$1,100,000
2012 Research expenses:$1,250,000
Total Research expenses:$3,334,000
Divided by 6 = $556,667
Excess of research expenses = $943,333 ($1,500,000 - $556,667)
Multiplied by 14% = $132,067 credit
In this case, the Alternative Simplified Credit would be more advantageous.
In June 2014, the IRS and Treasury Department announced new regulations allowing the ASC to be applied to amended returns. Previously, companies could only take the ASC on original returns, which greatly diminished the credit’s usefulness. Qualifying for the R&D credit requires substantial documentation, such as books and records, receipts, etc. For many companies, going through the process of applying for the credit simply has not been worth it for one year of the benefit ... until now.
Now more than ever, manufacturers—and other qualifying companies—should take a second look at research activities to see if they would qualify for the ASC under its new guidelines.
Find Out If You Qualify
The next step is to find out if your business would qualify for the R&D credit. While there are certain exclusions, it’s worth it to explore the
options. A good starting point is to perform two different calculations to see which method produces the best results.
Note: Although the R&D Credit technically expired on December 31, 2013, it has been retroactively extended every time it expired in the past. A final decision from Congress is not expected until after the November elections. Contact me at 412-281-8771 or at firstname.lastname@example.org if you have any questions about your company’s R&D tax credit application.
About the Author
Omar Thrower, CPA is a Tax Manager at Louis Plung & Company, a regional public accounting firm in downtown Pittsburgh. His practice focuses on corporate tax consulting for manufacturing and wholesale clients as well as investment partnerships.