Marcum 2021 Year-End Tax Guide

Research and Development (R&D) Tax Credit Applicability and Benefit The federal Research & Development (R&D) Tax Credit – originally introduced as a two-year incentive program under the Economic Recovery Tax Act of 1981 (ERTA) – has benefited thousands of companies from diverse industries over the past 40 years. While many U.S. businesses receive billions in tax saving through the R&D tax credit annually, the credit is often underutilized, particularly by small and medium-size companies, due to misconceptions such as: • The R&D tax credit would not benefit the taxpayer because the company is not profitable. • The R&D tax credit is only for big companies. • The R&D tax credit is not important since the taxpayer already gets a deduction. These misconceptions are preventing many eligible businesses from benefiting from a valuable and readily available incentive designed to promote growth and innovation. The R&D credit may be carried forward 20 years and back one year. In addition, some start-up companies may be eligible to claim a credit against payroll taxes, regardless of income tax liability. In addition, some states also offer R&D tax credits that companies may be missing. Big companies may claim larger credits due to the scope of their activities, but the federal program is open to any size entity. The credit is based on qualified activities, and not entity size. The credit, which is available and must be claimed annually, is in addition to a deduction for R&D expenses and represents a dollar-for-dollar reduction in income tax liability.

ELIGIBLE INDUSTRIES Industries where R&D-qualified expenses often occur include, but are not limited to:

• Manufacturing & Distribution • Software & Technology • Construction • Food & Beverage • Consumer Products

• Cannabis • Healthcare

CALCULATION The R&D credit is calculated by determining the amount of qualified research expenses (QREs) for the company’s current and prior three years. QREs consist of wages, supplies used in the R&D development, and 65% of third party contract research. In order to meet the definition of qualifying research expenses, research activities are required to be performed in the United States and need to satisfy the IRS “Four-Part Test”: 1. The work is being performed to develop a new or improved business component (product, process, technique, formula, invention, or computer software component). 2. The activities are performed to discover information that is technological in nature. The activities involve physical, biological, engineering, or computer sciences. 3. The research is performed to eliminate technical uncertainty, determine if a desired result could be achieved, how to achieve it, or determine the specific design of a product. 4. The activities will include a process of

experimentation involving identification of the technical uncertainties, alternatives to consider in eliminating the uncertainties, and a process for evaluating alternatives.

The R&D tax credit can provide significant benefits to taxpayers with qualifying activities. Recent changes to the Protecting Americans from Tax Hikes (PATH) Act of 2015, together with the 2017 Tax Cuts and Jobs Act (TCJA), have made the R&D credit more lucrative by providing taxpayers potentially larger credits for tax years ending after December 31, 2017.

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