Take Credit for Research and Innovation

By Trina Swart | October 18, 2011

Earning a tax credit for business research and development doesn’t require the use of a white lab coat. For years, the federal government and numerous states have rewarded companies that incorporate innovation and creativity to expand their product line. The credit has changed since it was originally put in place and currently the federal Credit for Increasing Research Activities is available to companies such as engineering companies, technology providers, agriculture operations and manufacturers—including ethanol production facilities.

As one of the most progressive, adaptive industries in the country, it makes perfect sense for biofuels companies to take advantage of this research and development tax credit. Maximizing this benefit can be accomplished in many ways. If a plant is working to create a new product line, modify an existing coproduct or improve current operational processes to become more efficient, this tax credit could apply. A manufacturer could be contracting research labor, using in-house labor or utilizing new materials, all of which can be applied toward the tax credit.

For many years, the credit required research activities include a discovery test for patents and inventions and extensive documentation. In 2003, the regulations changed to keep innovation and creativity in the U.S. The government eliminated the discovery requirement and modified the documentation standard. Congress later made it clear through legislative history that the credit should not impose unreasonable record-keeping requirements. And it increased the budget for this credit to $9 billion.

In 2005, 1,100 firms took $5.7 billion or 63 percent of the allowable credit. That year manufacturing alone earned 71.2 percent of credit dollars.
Currently, the rule identifies four criteria for the work to earn the tax credit. The work is 1) Aimed at implementing a new or improved business component,  2) Working toward the elimination of uncertainty, 3) Using a process of experimentation, and 4) The work must be technological in nature. The rule also allowed new industries such as engineering, chemistry, biology and computer sciences to qualify.

Manufacturing companies can take advantage of the credit through research and development activities already in place. A company could be working toward an improved product, incorporating new tooling or equipment fixture design, designing a unique computer numerical control program, redesigning manufacturing equipment, rolling out new products to clients, modifying machinery and equipment, implementing alternative materials testing, using new coating systems or implementing health and safety procedures or equipment. All of these things, and many more, are considered research and development eligible for the tax credit.

Keep in mind the end result of the research doesn’t have to be successful. Merely the action of using innovation or revamping a product is what this tax credit is all about.

One Kennedy and Coe client who manufactures equipment has utilized the Credit for Increasing Research Activities for the past four years. In the first year, the company saved approximately $40,000 in federal income tax by investing in new processes, design/model types and structures. The company continued to invest in engineering and new prototypes and in 2010, earned a $100,000 tax credit. These activities all made good business sense for the company and taking advantage of the research and development credit lets the federal government help pay the cost.

For every dollar of research and development, the average taxpayer receives seven cents back in tax credits. Often the results are much higher and there is no federal limit on the amount per company that can be saved. It’s also important to note that dollars invested are still valid business expense deductions while, in addition, a credit is generated that can be used directly against a tax liability.

When the federal government provides an opportunity like this, it is a no-brainer. Companies should be exploring this opportunity right now, while the tax planning window for 2011 remains open. Consulting your tax advisor about the Credit for Increasing Research Activities could mean significant tax savings in 2011.

Author: Trina Swart
CPA , Senior Associate, Kennedy and Coe LLC
(800) 303-3241