Manufacturers & Distributors ARTICLE -
Can You Benefit From the R&D Credit?
Target Audience: Manufacturing and Distribution Companies, M&D Industry, Tax Advisors, Business Owners
The research and development (R&D) tax credit can help support manufacturers’ innovative efforts, but some companies are still approaching research gingerly. Given the credit’s history, that’s understandable, but the tax advantages mean you should take a second look.
What Is It?
The R&D tax credit expired for the 13th time at the end of 2007, and wasn’t renewed again until the Emergency Economic Stabilization Act of 2008 (EESA) was signed into law in October 2008. Despite strong bipartisan support for making the credit permanent, EESA only extended the credit for 2008 (retroactive to Jan. 1) and 2009. (It’s possible that by the time you’re reading this article, however, the credit may have been extended again or even made permanent. Check with your tax advisor for the latest information.)
Under EESA, some manufacturers may be eligible for a credit for up to 20% of qualified R&D spending in excess of a certain amount based on the company’s historical activity. For those who don’t qualify for the full credit, the legislation increases the Alternative Simplified Credit (ASC) rate to 14% for 2009, while eliminating the Alternative Incremental Credit. Regardless of which benefit you claim, your company must prepare in advance.
Although the R&D credit is used by a lot of manufacturers, there are still many that don’t take advantage of it. Some don’t qualify for the credit, while others may be dissuaded by the complexity of the rules surrounding it.
The R&D credit is based on a manufacturer’s increase in R&D activities measured as a percentage of revenue over a historical baseline. If R&D expenditure growth outpaces revenue growth, you probably qualify. If, however, your R&D-to-sales ratio is lower now than during the base period (1984-1988), you can qualify for the ASC of 14% of the excess of your current year research expenses over 50% of your average R&D expenditures for the last three years.
Your tax advisor can help you decide which credit is appropriate, as well as how to document and claim the credit. This may require that you set up project accounting processes that will support your claims, as the IRS has designated the R&D credit a “Tier One” issue. That means they use a standardized process to audit credit claims, and examiners focus on documents created at the time the research was performed.
What Do You Need To Do?
To protect your tax advantage, thoroughly document your R&D projects. Establish project files and accounting processes immediately, and track progress and results during the project’s life.
Then use these guidelines to prepare yourself to withstand an IRS audit:
- Note significant dates from concept to commercialization.
- Work with your tax advisor to create narratives that discuss each project’s R&D credit qualifications.
- Link employee hours and activities to specific projects.
- Use calendars and other supporting documents to bolster timesheet entries.
- Identify supplies used in R&D for each project and segregate them in a separate general ledger account.
- Obtain work orders, itemized invoices or other documentation from contractors demonstrating the work performed on R&D activities.
- Specify who is assuming the financial risk and who will retain intellectual property rights for each project.
Risk and intellectual property assignments are required to claim the R&D credit, and the IRS has been critical of less-detailed methods of quantifying costs. Establish tracking systems that justify your claims.
The IRS doesn’t require manufacturers with several R&D projects to document each of them individually. Instead, you may use a statistical sample; a judgmental sample isn’t acceptable. Consult your tax advisor on how to assemble a sample that holds up to IRS scrutiny.
Why Do It?
It may seem daunting to create the records you’ll need to claim the R&D credit, but it will be time well spent. Not only will you see a tax reduction for the current year, but you may qualify for refunds if you can capture and recover credits for previous years.
Additionally, the R&D credit is a substantial tool to maximize your company’s value. Manufacturers rely on research to bring new products to market, and new products can increase market value, cash flow and your return on investment. They also help keep U.S. manufacturers competitive in the world market.
According to the National Association of Manufacturers, 18,000 companies use the R&D credit each year, with 70% of the credit dollars going to pay employees involved in R&D activities. That’s an advantage you really don’t want to miss.
Leasehold Depreciation Break Extended, Too
Manufacturers who used rented facilities as part of their operations may also benefit from another provision of the Emergency Economic Stabilization Act of 2008: the extension of the 15-year straight-line depreciation for leasehold improvements to include property placed in service before Jan. 1, 2010.
Qualified improvements include interior upgrades made more than three years after the building was placed in service, but not elevators, building enlargements or improvements to the building framework.
Manufacturers may depreciate such improvements over 15 years, rather than the 39-year depreciation schedule required for other improvements. Because as of this writing the extension is temporary, manufacturers who are considering leasehold improvements may want to complete them this year. But check with your tax advisor before taking action, because this tax break could be extended or expanded.
Find out how our M&D accountants can add value to your business. Email us or call us at 1 (888) 875-9770.
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