There's more to getting the R&D tax credits than meets the eye. For starters, a company needs to maintain a highly accurate engineering firm bookkeeping process in place. After that, firms need to know several things:
How much qualified R&D activity took place in the tax year
What activities meet the federal standard
What percentage of the qualified expenditures count toward the credit
The most difficult part of the process is not in the calculation of the amount of credit but in deciding which activities meet the definition of R&D tax credits for engineering firms. The IRS, for example, has strict requirements for documentation of the credit. That's why engineering firm bookkeeping staff need to keep detailed records of all expenditures related to R&D.
What Is the Credit?
The R&D tax credit began in 1981 as a temporary means of spurring research and development activity in the U.S. It's since become a permanent tax law and offers huge financial incentives for any company that meets its requirements. Traditional engineering firm accounting, especially when done in-house, often miss the chance to take the credit. Indeed, by some estimates, a very large number of firms that engage in valid R&D activity don't take the credit because they simply don't know that they qualify for it.
What is it, and how does it work? In general terms, if your company engages in any of the qualified R&D activities, you can take between 6 and 14 percent of those expenses as a direct credit against taxable income. If you have no income or have credits in excess of your income, you can carry the credit forward. The central question for engineering firm tax planning is this: which of our activities meet the federal definition of research and development?
What Is The "Four-Part Test"?
According to IRS regulations, a qualified expenditure must meet four separate requirements in order to come under the definition of "research and development expense." All activities, in order to be counted in the tax credit calculation, must:
Eliminate uncertainty: This part of the test pertains to an activity that works to reduce or eliminate uncertainty while developing a process or product.
Result from a "process of experimentation": Here, you need to show that you actually tested and evaluated alternatives to arrive at the solution you discovered.
Be technological in nature: There has to be hard science involved, like physics, computer science, chemistry, etc.
Have a qualified purpose: Your purpose has to be the creation of a new process or new product with an aim at boosting reliability, quality, function or performance.
Carrying The Credit Forward
R&D tax credits for engineering firms often add up to an amount in excess of the allowable annual credit, or a firm has no taxable income in a given year. When that happens, it's possible to carry the credit forward against future revenues for up to 20 years.
The carry-forward provision is just one reason it's imperative that every engineering firm find out exactly what current expenses qualify for the credit. Engineering firm accounting and engineering firm tax planning need to include separate calculations every year to reveal the amount of potential credit. Here at Fusion CPA, we have worked with many engineering firms to help them take the maximum R&D tax credit allowed by law. Our accounting experts are knowledgeable of recent tax codes and can help you build long-term value by implementing reliable financial tax planning strategies. You can learn more about our services by clicking the button below to schedule a complimentary discovery call today!
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive