The research credit provides tax benefits to companies that engage in qualifying research activities. It allows companies to deduct their research expenses and take a tax credit of up to 20% of qualifying research expenses over a calculated baseline. Proper documentation of research activities and expenses is critical to claiming the credit successfully during an IRS audit. The credit is available to companies of all sizes in many industries, but it often goes unused because companies fail to understand the opportunities it provides.

1. Presented by Barbara J. Oswalt, CPA/ABV, CVA, CFF
Copyright 2010

2. The credit is intended to help manufacturing
and technology companies be globally
competitive.
If a company takes a risk and spends money on
p y p y
developing a new or improved product or
process, the credit can lower a company’s
federal taxes!
Copyright 2010

3. Credit against federal income taxes for individuals
and companies who engage in qualifying research
You can deduct all of your research expenses AND
take the
t k th credit ( t a reduced percentage) or t k th
dit (at d d t ) take the
full credit and reduce your deduction by the amount
of the credit
Individuals & companies who apply for patents (other
than design patents) qualify – but that is not required
It is for unfunded research
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4. Research that is technical in nature is for use in developing a
new or improved “business component of the company
business component”
What is a “business component”?
Product
P d t
Process
Technique
Formula
Invention
Patent
Models or prototypes
Software
The improvement does not have to be significant
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5. g
Technological criteria
Must rely on principles of science including:
• Physical
• Biological
Bi l i l
• Engineering
• Chemical
• Computer sciences
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6. Elimination of uncertainty
Information sought must be intended to eliminate
uncertainty
Uncertainty exists if, when the research is begun,
the available information does not establish the
taxpayer’s capability, method or design of the
business component
p
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7. Process of experimentation
Research must substantially relate to new or improved
function, p
, performance, reliability, durability or q
, y, y quality
y
Experimentation is the evaluation of multiple
alternatives,
alternatives including developing and testing
hypotheses and including systematic trial and error
Experimentation goes beyond “lab work” – it includes
lab work
both conference room and shop floor experimentation
time
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8. Expenditures incident to the development or
improvement of a product or process
Expenses in the following categories:
E i h f ll i i
Wages
Supplies
Contract research
Costs and attorney’s fees associated with
obtaining a patent
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9. Research after beginning commercial production
Research paid for by a customer (or governmental entity)
Duplication of an existing product or process
Quality control testing
Advertising and promotion
Surveys or studies
Research conducted outside of the United States
Research in the social sciences, arts or humanities
The acquisition of another’s patent, model, production or process
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10. Regular credit
Use this if you have proper base period documentation
20% (or 13% if electing the reduced credit) of the excess of
qualified research expenses over a base amount
Use reduced credit if your combined tax bracket is at least 35%
Base is a fixed percentage of taxpayer’s average annual gross
receipts f
i from U.S. business for the last 4 years
US b i f h l
• Not less than 50% of qualified research expenses
• For a company started before 1984, the fixed percentage is the
percent of research expenses t gross receipts f ‘84 th
t f h to i t for through ’88
h
(not more than 16%)
• For a newer company, the fixed based percentage ranges from 3% to
16%
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11. Alternative simplified research credit:
14% (formerly 12%) of the excess of the research
expenses for the year over 50% of the average
research expenses for the three preceding years
h f h h d
Multiply by 65% for reduced credit
If no research expenses for any of the preceding three
years, 6% is used for the credit percentage
Once this method is used, it applies for all future
years unless revoked with the IRS’s consent
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12. Facts:
Research expenses for each year:
• 2009 - $ ,
$75,000
• 2008 - $40,000
• 2007 - $30,000
• 2006 - $20,000
Fixed base percentage – 5%
Average gross receipts for prior 4 years -
$1,000,000
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13. Average gross receipts $1,000,000
Fixed base percentage 5%
Net $ 50,000
Qualified research expenses $ 75 000
75,000
Multiplier 50%
Net $ 37,500
,
Smaller of these 2 amounts $ 37,500
20% of that amount $ 7,500
Reduced credit - 13% of that amount
d d d 3% f h $ 4,875
8
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14. Qualified research expenses
Q alified e penses $ 75,000
75 000
Less ½ of prior 3 year’s average $ 15,000
Difference $ 60,000
Applicable percentage 14%
Full credit $ 8,400
Reduced credit (65% of full credit) $ 5,460
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15. Who bears the economic risk?
The research cannot be funded by a third party
(y
(your customer or a g
grant)
)
BUT if payment for the research is contingent on
success, then the research is not considered funded
Taxpayer must have substantial rights to the
research
Unreimbursed contract overruns may qualify
Copyright 2010

16. Tax rules themselves
Credits only allowable to extent of regular tax over
alternative minimum tax (“AMT”)
AMT for passive investors (10 year amortization versus
deduction)
Net
N operating losses (BUT 1 year credit carryback and 20
i l di b k d
year carryover)
Base year computations may be an impossible hurdle
AND cannot use alternative simplified method or elect
the reduced credit on an amended return
Copyright 2010

17. Audit risk
Tier 1 audit issue
“Hot button” for the IRS
Key to successful defense is appropriate documentation
Patent safe harbor rule: issuance of a patent is
conclusive evidence that the taxpayer h di
l i id h h has discovered
d
information that is technological in nature – NOT
required
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18. Documentation is the absolute key
Create “nexus” between time spent and the specific
research activity
The credit includes wages for people who support
research activities
Management, engineering, plant supervisors, technicians and assembly
Possibly a sale person who is selling because he has a technical
background and experience and he uses this knowledge to make design
changes and modifications
g
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19. We can’t afford to properly document our expenses
– documentation does not have to be fancy, your
fancy
accountant can help!
We are not developing new products – the credit
also applies to improvements to existing products
or processes
The credit only applies to large companies – the
credit works well for all sizes of companies
It is impossible to get the credit – with proper
documentation and/or the use of a specialty firm,
y
you CAN g this credit!
get
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20. All manufacturers Other businesses
Chemical Dental laboratories
Packaging Metal fabrication
Furniture/household goods Tool and die
Aerospace/defense Software developers
Automotive Apparel designers
Metallurgy Engineering firms
Food/beverage processors
Marine/boat
M i /b
Mining
Glass
Biotechnology
Printing
Electronics
Robotics
Plastics
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21. This credit is one of the only ways to save
taxes that does not cost you additional
dollars over what you are already spending
The credit is there for you to use
Do NOT leave money on the table!
For more information, contact Barbara J. Oswalt
Phone: 321-255-0088
y
Email: boswalt@hoyman.com
Copyright 2010