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  1. Home
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  3. Misconceptions About the Research & Experimentation Tax Credit

Misconceptions About the Research & Experimentation Tax Credit

Posted by Tim Finerty and Bryan Powrozek on February 15, 2021

Tim Finerty Tim Finerty

As companies put more emphasis on Industry 4.0 and business processes become more automated and accessible, the opportunities for Research & Experimentation tax credits increase. The Research and Experimentation (R&E) tax credit, commonly known as the Research and Development (R&D) tax credit is a tax incentive that can provide tax benefits for companies investing in R&D. Many companies have qualified research activity; however, most businesses do not fully leverage this tax incentive. Learn what is considered a qualifying activity and discover what areas are most often overlooked when calculating the credit.

What Type of Activity Qualifies?

There are three prongs to the definition of the term qualified research. Qualified research includes:

  1. Research expenditures which may be treated as deductible expenses under the provisions of the tax code
  2. Research that is undertaken for the purpose of discovering information which is technological in nature and, the application of which, is intended to be useful in the development of new or improved business components
  3. Substantially all the activities that constitute elements of a process of experimentation for a functional purpose

What Does This Mean?

The most common misconception regarding the R&D credit is that companies must be inventing something entirely new or groundbreaking to qualify for the credit. However, back in 2003 the IRS loosened qualifications to include development efforts which only need to be evolutionary to you. In other words, if employees in your organization are spending time to discover technical information through research and experimentation, with the intention of developing or improving products or trade processes using the principals in Industry 4.0, those expenses will generally be qualified research and development costs for purposes of the credit.

Research expenditures generally include costs incidental to the development or improvement of a product, process, formula, invention, technique, patent or similar property.

The discovery requirement is satisfied if the research is “intended to eliminate uncertainty concerning the development or improvement of a business component.” The test is taxpayer-focused rather than industry-focused, which means it does not matter if another company has developed the product or process. If there is an element of uncertainty in the activity you are engaging, it may be a qualifying activity. Eligibility does not depend upon the ultimate success, failure, sale or use of the product. Typically, costs are eligible until the element of uncertainty is eliminated.

The process of experimentation test requires a facts and circumstances analysis; however, the IRS has provided three core elements needed to satisfy this test:

  1. Identifying uncertainties
  2. Identifying alternative solutions
  3. Evaluating the identified alternative

If your process includes all three steps, it is likely a qualifying activity.

Identifying Research Expenditures

Many companies aren’t aware that a product or process merely needs to be evolutionary to them in order to qualify. In addition, Clayton & McKervey has encountered many companies utilizing the credit, but not to the fullest extent.

Identifying qualifying expenditures is usually an area most taxpayers misunderstand. Costs incurred in the development or improvement of a plant process, a product and a technique are all qualifying expenditures. To put that into context, a system integrator often improves a product or technique for each automation cell produced. In that regard, the costs incurred to engineer and test a cell would be qualified expenses. If the cell is duplicated, only the costs incurred for the first cell would be qualified; however, most cells have a unique component.

If business owners drill down even further and question what type of costs are considered research costs for purposes of calculating the credit, they would find that many supply costs are also included in the definition of qualified expenditures. We have found supply costs are often an overlooked expenditure for purposes of the credit calculation, and often these are the largest costs incurred in the development of an automation cell.

How Much Is the Credit?

Typically the credit will be about 5 -10% of qualified research expenditures. The credit may be carried back one year and carried forward 20 years.

Contact Us

If you think you may qualify for the credit, or may not have utilized the credit to its fullest extent in prior years, there may an opportunity to amend returns and apply for a refund or credit carryover. For additional information call us at 248.208.8860 or click here to contact us. We look forward to speaking with you soon.

Our team is always ready to help.

Please contact us for more information.

Tim Finerty

Tim Finerty

Shareholder, Industrial Automation

Contact Tim   |   Read Tim's bio

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Misconceptions About the Research & Experimentation Tax Credit

Posted by Tim Finerty on February 15, 2021

Tim Finerty

As companies put more emphasis on Industry 4.0 and business processes become more automated and accessible, the opportunities for Research & Experimentation tax credits increase. The Research and Experimentation (R&E) tax credit, commonly known as the Research and Development (R&D) tax credit is a tax incentive that can provide tax benefits for companies investing in R&D. Many companies have qualified research activity; however, most businesses do not fully leverage this tax incentive. Learn what is considered a qualifying activity and discover what areas are most often overlooked when calculating the credit.

What Type of Activity Qualifies?

There are three prongs to the definition of the term qualified research. Qualified research includes:

  1. Research expenditures which may be treated as deductible expenses under the provisions of the tax code
  2. Research that is undertaken for the purpose of discovering information which is technological in nature and, the application of which, is intended to be useful in the development of new or improved business components
  3. Substantially all the activities that constitute elements of a process of experimentation for a functional purpose

What Does This Mean?

The most common misconception regarding the R&D credit is that companies must be inventing something entirely new or groundbreaking to qualify for the credit. However, back in 2003 the IRS loosened qualifications to include development efforts which only need to be evolutionary to you. In other words, if employees in your organization are spending time to discover technical information through research and experimentation, with the intention of developing or improving products or trade processes using the principals in Industry 4.0, those expenses will generally be qualified research and development costs for purposes of the credit.

Research expenditures generally include costs incidental to the development or improvement of a product, process, formula, invention, technique, patent or similar property.

The discovery requirement is satisfied if the research is “intended to eliminate uncertainty concerning the development or improvement of a business component.” The test is taxpayer-focused rather than industry-focused, which means it does not matter if another company has developed the product or process. If there is an element of uncertainty in the activity you are engaging, it may be a qualifying activity. Eligibility does not depend upon the ultimate success, failure, sale or use of the product. Typically, costs are eligible until the element of uncertainty is eliminated.

The process of experimentation test requires a facts and circumstances analysis; however, the IRS has provided three core elements needed to satisfy this test:

  1. Identifying uncertainties
  2. Identifying alternative solutions
  3. Evaluating the identified alternative

If your process includes all three steps, it is likely a qualifying activity.

Identifying Research Expenditures

Many companies aren’t aware that a product or process merely needs to be evolutionary to them in order to qualify. In addition, Clayton & McKervey has encountered many companies utilizing the credit, but not to the fullest extent.

Identifying qualifying expenditures is usually an area most taxpayers misunderstand. Costs incurred in the development or improvement of a plant process, a product and a technique are all qualifying expenditures. To put that into context, a system integrator often improves a product or technique for each automation cell produced. In that regard, the costs incurred to engineer and test a cell would be qualified expenses. If the cell is duplicated, only the costs incurred for the first cell would be qualified; however, most cells have a unique component.

If business owners drill down even further and question what type of costs are considered research costs for purposes of calculating the credit, they would find that many supply costs are also included in the definition of qualified expenditures. We have found supply costs are often an overlooked expenditure for purposes of the credit calculation, and often these are the largest costs incurred in the development of an automation cell.

How Much Is the Credit?

Typically the credit will be about 5 -10% of qualified research expenditures. The credit may be carried back one year and carried forward 20 years.

Contact Us

If you think you may qualify for the credit, or may not have utilized the credit to its fullest extent in prior years, there may an opportunity to amend returns and apply for a refund or credit carryover. For additional information call us at 248.208.8860 or click here to contact us. We look forward to speaking with you soon.

Our team is always ready to help.

Please contact us for more information.

Tim Finerty

Shareholder, Industrial Automation

Contact Tim   |   Read Tim's bio

related news

How to Claim R&D Tax Credits

Part four of our R&D series answers two common questions about the R&D tax credit: How do I claim the R&D tax credit? Do I really need to claim the…

Read full story

IRS Issues New Guidance on PPP and Employee Retention Credit Eligibility

The IRS issued highly anticipated guidance regarding the employee retention credit (ERC) on March 1. We have previously outlined how the Consolidated Appropriations Act, passed in December, permitted employers receiving…

Read full story

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In honor of International Women’s Day, I’d like to take a moment to recognize the talented women who have helped build our outstanding reputation within the business community – both…

Read full story

How to Calculate R&D Tax Credits

As we’ve seen in the first two installments of this series, business owners often miss out on the R&D tax credit opportunity and the bottom-line infusion it can provide. Many…

Read full story

Doing Business in Mexico: What to Expect this Year

Without a doubt, this year will be interesting for Mexico. To start, it’s an election year and we all know what that means…a lot of uncertainty. As the global pandemic…

Read full story

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