 Accounting
Best Practices
Tax Credits
That May Surprise You
You CAN Afford Research and
Development
By: Tatiana Gilberston
Because of advances in
communication, information processing and transportation
technology, today’s economy is much different than our
economy of a few decades ago. These factors, and the
lowering of trading barriers, have resulted in a global
economy that has introduced hundreds of new competitors
to the mix. This increase in competition is one of the
primary reasons that companies focused on sustaining
profitability and market share continue to invest
significant sums to improve their existing products and
processes and/or create new products and processes.
These expenditures are generally classified as research
and development (R&D) and in 2006 U.S. R&D spending was
$330 billion, making us the largest R&D spenders in the
world.
For
income tax purposes, these expenses may be deducted in
the tax year in which they were paid and/or incurred, or
amortized over a period of not less than 5 years. In
addition to these deductions, Congress has encouraged
investments in R&D by creating an R&D tax credit in
1981. The credit, which was established to address
perceived problems in the competitive position held by
US companies at that time, was initially expected to be
temporary in nature, however it continues to be extended
and currently is set to expire on December 31, 2007.
The
nature of the activity determines whether a particular
expenditure qualifies as R&D expenditure. Qualifying
research means research undertaken for the purpose of
"discovering information":
-
Which
is technological in nature;
-
Which
tends to be useful in the development of a new or
improved business component of the taxpayer; and
-
Which
constitutes elements of a process of experimentation
that relates to new or improved functions, performance
and/or reliability or quality.
An
example of an activity that you might not ordinarily
consider as qualifying would be as follows:
X, a
manufacturer, wants to develop a new and more efficient
process to manufacture a new widget. X determines that
it requires a specialized type of robotic equipment not
commercially available, and X therefore purchases
existing robotic equipment for the purpose of modifying
it to meet its needs. X's engineers identify the
uncertainty that is technological in nature concerning
how to modify the existing robotic equipment to meet its
needs. X develops several alternative designs, and
conducts (1) experiments using modeling and simulation
to modify the equipment and (2) extensive scientific and
laboratory testing of design alternatives. As a result
of this process, X develops a design for the equipment
that meets its needs and is able to construct and
install the modified equipment in its manufacturing
process. Substantially, all of these activities qualify
for the credit.
For most
entities, the credit will be equal to 20% of the
qualified research expenses above a base amount of such
expenses for the year. This base amount is calculated
by multiplying an entity’s fixed-base percentage by the
average amount of its gross receipts for the four
preceding years. For example, assume we wish to
calculate the R&D credit for 2006 assuming the following
amounts:
The
total qualified research expenses of $390,000 for years
1-5 are divided by the total gross receipts of
$4,200,000 for such years to arrive at a "fixed-base
percentage" of 9.29%. The average annual gross receipts
of $925,000 for the 6th year are determined by averaging
the annual gross receipts for the preceding 4 years
(i.e., $3,700,000 /4). Therefore, the current year base
amount for the entity is $85,932, or 9.29% of
$925,000. In this case, the R&D credit would be
$12,814, or 20% of $64,068 (which amount is calculated
as $150,000 of current year qualified research expenses
less the base amount of $85,932). Keep in mind this
amount is a dollar-for-dollar tax credit not a tax
deduction.
In those
cases in which the base amount is lower than 50% of the
current year expenditures, the taxpayer can receive a
credit based upon 50% of the current year expenses.
In
addition, for tax years ending in 2007, even those
taxpayers that do not have revenues may be able to
qualify for the credit, as they can elect to use a new
"alternative simplified credit." It is calculated as 12%
of the excess of qualified research expenses over 50% of
the average qualified research expenses for the three
tax years proceeding the tax year for which the credit
is being determined. Furthermore, if a taxpayer does
not have qualified research expenses in any one of the
three preceding tax years, the alternative simplified
research credit is simply computed as 6% of the entity’s
current year's qualified expenses.
As you
can see, thanks to the generosity of our Congress,
research and development expenses can be reduced
significantly through proper planning and
implementation. Please feel free to contact us is you
have any questions or desire additional information
about this matter.
Tatiana Gilberston is a
member of the Tax team at Kingery & Crouse. A graduate
of the University of South Florida with an MBA degree,
she has previously worked on the Audit team. Tatiana
speaks English, Spanish & German fluently. Kingery &
Crouse, P.A. is a full service public accounting firm
with a staff of 23 dedicated professionals providing tax
and accounting services, including audits of SEC
companies. You may contact Tatiana at (813) 874-1280 ext
#228. Find us on the web @
www.tampacpa.com.
Published August 2007,
Volume 1, Number 5,
Bay
Area Business Magazine
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