February 13th, 2017 The R&D Tax Credit: IT’S NOT just ROCKET SCIENCE! – by David Lichtenstein, CPA, MST You know that guy, right? The one who always manages to blurt out “It’s not rocket science!”, when you are struggling to figure something out. Don’t be that guy. Don’t be that guy who loves to state the obvious. I mean really, does anyone ever just casually dabble in the science of rockets without knowing that they are doing so? Well, assuming you are not that guy (if you are that guy, then this is really awkward), I have a suggestion for you. The next time you hear that annoying phrase while you are brainstorming at work on how to build a better widget, why don’t you say: “I know, but there’s still a chance that I can receive a Federal R&D tax credit for doing it!” Huh? Yes, that’s right. Today’s Federal R&D tax credit is no longer just for rocket scientists. In the olden days, when dinosaurs roamed the Earth, the credit was so restrictive and exclusive (in that it required an extremely high level of innovation), the perception was that you needed to be engaging in rocket science in order to benefit from the credit. However, over the years, Congress has expanded its reach (the credit that is, not Congress itself), simplified its calculation, and, most recently, taken away a few major barriers that have prevented many credit eligible taxpayers from actually pursuing and utilizing the credit. Before we get into the elimination of the aforementioned barriers, let’s get the lay of the land with respect to what types of activities actually qualify for the credit. Follow me as we take a virtual walk around the corporate office park and listen in on some typical conversations describing eligible R&D credit activity. See if you can’t identify the concepts that create eligibility. (Hint: look for print in BOLD CAPS) Inside Building 210 Morgan: “Sidney, why is there a raging fire over by the flex assembly wheel?” Sidney: “I was just trying to see if I could increase production output by almost 50% by jimmying the flux capacitor and bypassing the fly chute, thereby forcing the widgets through the flex assembly wheel. It obviously didn’t work, but you can’t fault me for trying to IMPROVE OUR PROCESS, right? Inside Building 525 Jorge: “Monica, why does this pie crust taste like cardboard?” Monica: “Um, that’s because it is cardboard. I was trying to see if I could DEVELOP A NEW FORMULA for the pie crust ingredients that would deliver the same great taste and quality, and enable us to save money by using alternative raw materials. And to top it all off, as the pie crust is cardboard, the pie itself can serve as its own packaging! Think of all the money we could save by using all of the return boxes that we receive every day from our…um.. “less than satisfied” customers.” Inside Building 750 Wonka: “Violet, try this gum that I’ve been experimenting with. I’ve been trying to DEVELOP A NEW PRODUCT, and this gum will hopefully provide both a nice flavor and the sensation of having eaten a full three course meal.” Violet (After shoving several packets into her mouth): “What’s happening to me? I’m feeling sick!” Wonka: “You’re turning violet, Violet! Like I said, I’m still experimenting with it.” Inside Building 950 Victor: “Hey Sam, what’s with the mini-Egyptian pyramid that’s blocking the hallway?” Sam: “That’s a great name for it! It’s this cool NEW ENGINEERING TECHNIQUE that I have developed, but I couldn’t think of what to call it. Thanks!” Victor (to Suzie): “Should I tell him?” Suzie: “Nah. Let’s not burst his bubble. The good news is that the R&D credit does not necessarily require that you invent something that’s new to the world. It just needs to be new to you.” END OF OFFICE PARK VIRTUAL TOUR I must admit that the last example is a bit of a stretch in describing a situation where the concept only needs to be new to you in order to be eligible for the credit. You still have to pass the reasonableness test, and hiring the world’s most oblivious engineer doesn’t give you a free pass. What I am alluding to is this: There are more concepts that need to be grasped in order to obtain a clear understanding of how this credit works. However, don’t fret. It’s our job as CPA’s to know these details and make an assessment of your eligibility. Suffice it to say that you are generally on the right track for a credit if your activities cover all four of the following areas: 1) The activity is undertaken to develop or improve a product, process, design, or technique; 2) The activity involves a process of experimentation; 3) The activity involves a significant degree of technical uncertainty; and 4) The activity relies on the principles of engineering, physical science, computer science, or biological science. Now that you’ve got a better understanding as to what qualifies as an R&D credit activity, let’s finish off by briefly discussing the elimination of some major barriers to utilizing and actually benefitting from the credit: No Income Tax? No Problem! So your business has lots of losses, and therefore no income tax liability. So no need for a tax credit, right? WRONG!! Effective for 2016, Congress is now allowing “start-up businesses” (i.e. generally businesses that have been in existence for less than five years and have less than $5 million in gross receipts in any given credit year) to elect to use their R&D credits to offset up to $250,000 of payroll taxes for each year that they continue to qualify as a “start-up business”. Swipe That Axe To Alternative Minimum Tax! Prior to 2016, if a taxpayer was subject to Alternative Minimum Tax (“AMT”), the R&D credit was virtually useless, as it could not be used to offset AMT. Well, the big, bad AMT just took a big blow to the kisser! Effective for 2016, the R&D credit can now be used to offset AMT liability for businesses with a rolling prior three year average gross receipts of not more than $50 million. Let me end this discussion by saying that now is a great time for CPA’s, rocket scientists, and the typical run of the mill innovative entrepreneurs to get together and perhaps renew an old conversation about the R&D credit, because it is here to stay, and better than ever. Anyway, it’s been real, but I’ve got to get back to my other job: Reducing your taxes and boosting the economy. I can’t promise that I will write every month, but if you keep reading, I’ll keep writing. My goal is to keep you, the taxpayer, informed on tax issues that matter to you, your family, or your business. And if there’s a tax issue out there that you’d like to know more about (AMT anyone?), or if you have questions about a recent post, feel free to reach me about my new blog: Sir-Tax. I may just pick your issue for my next post. Happy Tax Season! DISCLAIMER: Sir-Tax is a personal blog. 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