Research and Development Tax credits are often overlooked and misinterpreted by many small and mid-size businesses, too include their accountants’ understanding of the credit, and why many businesses continue to miss out on a very valuable influx of cash refunds year after year after…
No the Research and Development Tax Credit is not available to only those that have on-site laboratories or have developed breakthrough research to claim such credits. Many business owners in nearly every industry are unaware that the research and development tax credit exists to reward day-to-day efforts aimed at producing and improving their products and/or services.
Before jumping into an applied example of the research and development tax credit let’s first understand quickly the language of the code and what “R&D really means as it relates to qualifying activity.
Internal Revenue Code 41 known as the Research & Experimentation Tax Credit or the R&D Tax Credit is a general business tax credit for companies that are incurring R&D expenses in the United States. The R&D Tax Credit was originally introduced in the Economic Recovery Tax Act of 1981 sponsored by U.S. Representative Jack Kemp and U.S. Senator William Roth. Since the credit’s original expiration date of December 31, 1985, the credit has expired eight times and has been extended thirteen times. The current extension is set to expire December 31, 2011.
Generally, qualified research is an activity or project undertaken by a taxpayer (directly or through direct funding of a third party on the taxpayers behalf) that comprises each of the four distinct elements:
Permitted Purpose: The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component. A business component is defined as any product, process, technique, invention, formula, or computer software (see exclusion for internal use software below) that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.
Elimination of Uncertainty – the taxpayer must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development or improvement, or the appropriateness of the business component’s design.
Process of Experimentation: the taxpayer must undergo a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer’s research activities. Treasury Regulations define this as broadly as conventional implementation of the scientific method to something as informal a systematic trial and error process.
Technological in Nature: the process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement.
Application of the Research and Development Tax Credit: Mold Maker
3 year tax study
Qualified Expenditures: $3 million
Federal Credit: $250,000.00
XYZ Mold Co. specializes in the design, development and production of rubber injection molds for the automotive and trucking industries.
The company produces in excess of 100 injection molds per year. The typical duration for the development of production mold is 11 weeks from start to finish. Approximately 70% of the company’s projects require the development and the testing of prototype molds before manufacturing of the production mold. Single cavity prototype molds require additional development time.
The company utilizes a design studio, CNC work cells, and various other manufacturing equipment including injection molding machines for the testing and validation of prototypes and new production mold designs.
Injection molding is a manufacturing technique for making parts from both thermoplastic and thermosetting plastic materials. Molten plastic is injected at high pressure into a mold, which is the inverse of the product’s shape. After an engineer has designed a product, a mold is made by a mold maker or toolmaker from metal, usually either steel or aluminum, and precision-machined to form the features of the desired part.
XYZ Mold Co. thus designs, and developes new molds for the injection molding industry. The company has developed specialized knowledge in the design and development of injection molds for the automotive and trucking industries.
The engineers and designers on-staff are experts in the design of molded parts and molds. Many complex considerations and elements of uncertainty come into play during the design and development phase, which must ultimately be resolved through computer-aided-design, computer-aided-eingineering, and the prototype process to ensure that a design alternative will be functional. These challenges include insuring that the parts will not be trapped in the mold due to varying features; that the molds can be completely filled before the molten resin solidifies (no voids) and material shrinkage and varying cooling rates are addressed; and that imperfections in the parts are minimized.
Example of 4 Part Test Satisfaction
- Permitted Purpose– The development activities of XYZ Mold Co. meet the requirements for Permitted Purpose because the activities are related to the design and development of new molds for the injection molding of designed parts and the development of new or improved manufacturing processes or techniques intended to translate the design into prototypes and models.
- Technological in Nature– The research, design, and development of the various injection molds developed by XYZ Mold Co. during the period under study relied upon and involved theories, concepts and knowledge for physical or biological sciences, engineering, or computer science including mechanical engineering, materials science, metallurgy, and manufacturing technologies.
- Process of Experimentation– Throughout the design process and development life cycle of each injection mold, the Company employs a process of experimentation by continually developing and refining initial concepts, building prototypes, testing and evaluating prototype models, and discarding or eliminating design alternatives until a model or mold is developed that meets or exceeds the requirements of the project.
- Elimination of Uncertainty– XYZ Mold Co. encountered and eliminated uncertainty in the design and development of each injection mold. Examples of this uncertainty include: Can Mold Co. design and develop an injection mold capable of meeting the parameters and requirements of the specifications for the end product? What is the optimal design configuration of the injection mold? What slides, draft angles, and other features may be required in the design to successfully form the desired parts? What is the optimal material type for the mold? Given a specified material type for the end product, how will varying cooling rates affect part shrinkage and, thus, the overall design of the injection mold? What is the optimal number of cavities and runner systems for each injection mold? Will the injection mold’s performance level meet or exceed the levels required to make it a viable and successful product?
In addition to the federal credit, research tax credits have been adopted by many states. While many states follow the R&D tax credit, it is advisable to confirm with the state the current R&D tax credit legislation.
The legislative intent for the R&D Tax Credit is to increase R&D spending in the United States. Currently separate bills are being proposed in the House of Representatives and the Senate. The House of Representatives bill, cosponsored by U.S. Representatives Kendrick Meek and Kevin Brady, H.R. 422 proposes to make the credit permanent and increase the Alternative Simplified Credit from 14% to 20%.
Senators Max Baucus and Orrin Hatch are cosponsoring bill S. 1203. This bill proposes to make the credit permanent, increase the Alternative Simplified Credit from 14% to 20%, and terminate the other calculation methods.
In the112th Congress, Representative Rush Holt is sponsoring H.R. 134 to make the R&D Tax Credit permanent.