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Receiving Credit for the Pursuit of Innovation: Research and Expense Credit

Posted 8:10 PM by

It is not often that one gets rewarded for current efforts and not just success. This rings especially true when applying this thought to a business owner focused on building and operating a successful company. Fortunately, the IRS has decided to go against the norm and incentivize business innovation. The Credit for Increasing Research Activities – better known as the Research and Expense Credit – is an income tax credit available to taxpayers of any size that design, develop or improve products, processes, techniques, formulas or software. 

The credit is based on research and development costs, not the income related to the new development. For the IRS, research and developmental expenses include costs incurred to provide information that would eliminate uncertainty about the development or improvement of a product. The IRS has been kind enough to specifically note that the term “product” for these purposes can include formulas, inventions, patents, pilot models, processes or even techniques. 

Once the expense can be included as a research and development expense in the eyes of the IRS, there are three more tests that have to be passed:

  1. The research activity must be for the purpose of discovering information, which is technological in nature. In short, you must rely on the physical, chemical and biological sciences, as well as engineering, computer science, or another technological basis for the discovery.
  2. The application of your discovery, or technological information, must be intended to be useful in your new or improved business component or process. 
  3. Substantially all of the research activities must constitute a process of experimentation. 

After the boring definition provided by the IRS, we can get into the meat of the credit for most business owners: the value of the credit. Depending on how the credit is calculated, it can equal 13-20% of your qualified research expenditures over a calculated base amount. This amount can quickly increase when factoring in all of the expenses associated with the qualified research activity, including wages, supplies, computer leasing costs, and even contract research expenses. It is also important to note that Indiana also provides a 15% research credit that is defined and calculated similarly to the federal credit, but it is only available for research conducted within Indiana.

Is your company developing new or improved products or processes? If so, you may be rewarded for your innovation. This article may not provide all of the tools to fully understand the research and expense credit, but, hopefully, it allows you to ask the right questions. For more information, contact your KSM advisor.

*Please note that the Research and Expense credit expired 12/31/2011. We anticipate Congress will extend the credit, retroactively covering expenses incurred beginning 1/1/2012.

About the Author
Ali Todd is a director in KSM’s Veterinary Services Group. Ali works closely with clients to understand their challenges and provide practical solutions, whether it is tax planning or creating an action plan for enhancing profits.

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