Tax Credits
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The research and development (R&D) tax credit is one of the most significant domestic tax credits remaining under current tax law. It is an important tool for corporates investing in R&D for tax planning strategies and maximizing the company's value. R&D tax credit also known as Research and Experimentation (R&E) tax credit, is a federal benefit that provides companies dollar-for-dollar cash savings for performing activities related to the development, design, or improvement of products, processes, formulas, or software.
Benefits of R&D Tax Credit
- On an average 12-16% of federal and state R&D tax credits for every qualified dollar
- Dollar to Dollar set off on Federal or State Income tax liability.
- Improved Cash flow
- Incentive to hire new employees, expand business and create new facilities
- Reduction in tax outgo
- Carry forward of credit for up to 20 years
- Utilize the federal R&D tax credit against payroll tax (applicable to certain startup companies)
Test for determining an activity to be treated as R&D
- The Section 174 Test
- Discovering technological Information Test
- Business Component Test
- The Process of Experimentation Test
R&D credit limitation
A taxpayer can't both deduct research costs and claim a research credit for the same expenditure; there is no double tax benefit. Under I.R.C. §280C, a taxpayer must reduce the research expenditure deduction otherwise allowable by the amount of the research credit claimed.
If a taxpayer capitalizes rather than deducts research expenditures, and the research credit for the year exceeds the amount allowable as a deduction for qualified or basic research expenses, then the amount chargeable to the capital account for such expenses must be reduced by the amount of the excess.
However, taxpayers may elect to reduce their research credit instead of reducing their research expenditure deduction or capitalized amount.
As discussed above, no current deduction will be allowed for research or experimental expenditures paid or incurred in tax years beginning after Dec. 31, 2021.