Research & Development (R&D) Credit Essentials

Many businesses regularly conduct research and development projects to improve processes and efficiencies and to uncover ways to make new and more valuable products. Companies with dedicated research and development functions invest significant human and financial resources in the process. Others without a formal department often invest in such activities continuously with a limited scope. These activities are essential because they help to create new or improved products and uncover efficiencies and enhancements. While helpful, these activities can be pretty expensive, leaving management unable to continue efforts in the long term.

This is why many turn to the Federal R&D Tax Credit to help offset the costs. Initially created in 1981, its purpose is to support business investments in research and development, allowing for significant tax benefits. Unfortunately, many do not take advantage of the incentive due to misconceptions about eligibility or a lack of awareness. The result is that millions of dollars in potential credits go unclaimed each year. To help clients, prospects, and others, Wilson Lewis has summarized essential information below.  

What is the R&D Tax Credit?

A federal incentive that allows companies to generate dollar-for-dollar tax savings for performing eligible activities. The potential savings can be significant and provide needed funding to hire new employees, increase R&D activities, and expand various facilities. The IRS has published a four-part test requiring R&D projects to pass to determine eligibility. It is important to note that this program differs from the Georgia R&D Tax Credit, a state-based credit.

Who Qualifies for the Credit?

Any business that improves products, processes, or software formulas may qualify. It is important to note that some level of technical experimentation must be built into the process. While no one is explicitly excluded, some industries are naturally more likely to benefit. This includes manufacturing, software development, agriculture, medicine, and aerospace, to name a few. The main requirement is that businesses should be engaged in activities that meet the four-part test for qualified research.

What is the Four-Part Test?

To be eligible to claim the R&D tax credit, organizations should engage in truly innovative activities. These activities need to meet the following criteria:

1. New or improved: Create a new or improved product, software, or process that improves performance, quality, functionality, reliability, or a similar concern. These projects can build on previous research and don’t have to be large in scope.
2. Elimination of uncertainty: The activity’s goal should be to eliminate uncertainty in one or more parts of a project, including design, capability, and methodology. Even if the project doesn’t eliminate uncertainty, the effort may still count.
3. Experimentation: Some level of experimentation must be involved to address and eliminate the uncertainty. This needs at least 80% of activities that would fall under the credit.
4. Technological: Finally, the project needs to be technological in nature, so it should arise from the principles of computer science, biological science, engineering, physical science, or applications of these sciences and technologies.

How much can I save?

The amount a business can save with an R&D tax credit will depend on its size and the amount invested in qualified research activities. Typically, the credit can offer a dollar-for-dollar reduction in federal tax liability, meaning that every dollar they qualify for in tax credit also reduces their tax bill by that same amount. To calculate savings, it’s best to consult a tax professional.

Recent Changes

The Tax Cuts and Jobs Act (TCJA) changed how businesses apply the research and development tax credit. Before TCJA, most R&D expenses were 100% deductible in the current tax year in which they were incurred. Afterward, taxpayers were required to capitalize and amortize expenses over five years for domestic R&D and 15 years for overseas projects.

Recently, the House of Representatives passed H.R. 7024, the Tax Relief in American Families and Workers Act of 2024. The next stop is the Senate. If passed into law, it would reinstate full deductions for domestic research but may leave the rule for capitalization and amortization unchanged for overseas expenses. It is still under consideration, but many hope it will be signed into law by early.

Contact Us

The R&D tax credit offers compelling savings to eligible taxpayers. Since determining eligibility can be complicated, it is essential to consult with a qualified tax advisor. If you have questions about the information outlined above or need assistance with another tax matter, Wilson Lewis can help. For additional information, call 770-476-1004 or click here to contact us. We look forward to speaking with you soon.