Research and development, usually shortened to R&D, calls to mind an inventor designing a functional jet pack or scientist creating a new medicine to treat a deadly disease. R&D, however, can be any research that is then applied and developed into a function (or functions). Any research that leads to innovation and a new product, a new service or a new process can be considered the result of “R&D.”
When it comes to Federal taxes, however, claiming an R&D credit is a little more complex. The IRS has specific definitions, as you might imagine.
First of all the research has to be expenses that can be treated as “section 174” expenses. This expense has to be directly connected to the business and must be directly related to R&D. The expense has to be PART of doing the research. It can include wages paid to employees doing the lab work or experimentation as well as the wages paid to employees directly supervising that work.
The research also has to be technological in nature and has to develop a new (or improved) “business component.” What exactly is a business component? According to the IRS it is “any product, process, computer software, technique, formula, or invention which is held for sale, lease, or license or used in the taxpayer’s business.”
The possible interpretations of what this means are vast compared to the IRS definitions.
Are your eyes glazing over yet? This is why specialized accounting is so important. Having an expert who has worked with businesses doing R&D is key.
Another important aspect of claiming R&D tax credits is what is NOT allowed. Research conducted after the beginning of commercial production is a “no no”. Likewise research that adapts an existing product/process to a particular customer. Surveys and studies cannot be claimed. The duplication of an existing product or process cannot be claimed. Research related to some types of internally used computer software cannot be claimed.
As you can see the details quickly become hard to parse.
These are just a selection of things that might seem to qualify but do not. It is far from comprehensive. All of these examples are from IRS form 6765. The point here is that it is easy to read the words on a form and difficult to apply them to your taxes. For instance, developing software might be allowed, unless it is a specific sort of software used for a specific purpose. Where is the line drawn? Specialized accounting assistance can save you money and problems down the road.
At Hito, our tax credit experts can help you determine if you qualify, and if you do, we help you prepare and file the necessary documentation. Connect with us to request for your complimentary assessment. And check out our website for more information.
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