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The R&D tax credit is a government-sponsored tax incentive that was created 38 years ago by Congress to entice companies to innovate and create technical jobs in the United States. Basically, it is a job credit that reduces federal and state income tax liabilities.

2021 has arrived with some changes in the research and development (R&D) tax incentive. Discover below the modifications that you and your company should be aware of:

  • R&D is a permanent tax incentive (PATH Act)
  • “Discovery test” eliminated (business process improvement and modifications are now considered an R&D activity/expenditure)
  • Audit examination is no longer considered Tier 1
  • Taxpayer must provide “NEXUS” between business R&D activities and expenditures. Documentation requirements have been simplified
  • Capitalized expenditures (CapEx) may be used as an R&D activity and expenditure
  • Internal use software has been modified and considered an R&D activity
  • Alternative Simplified Credit (ASC) calculation streamlines the R&D process for current, and now for prior tax years
  • R&D may be used to offset payroll taxes for start-up companies
  • R&D may be used as an offset against the Alternative Minimum Tax (AMT) for flow-through companies with revenue less than $50m (PATH Act)
  • Relevant court cases in favor of taxpayer (Trinity, TG Missouri, Union Carbide, FedEx, McFerrin, P & G, Populous Holdings)
  • Base year calculation – “consistency rule” modified
  • Activities include (frequently missed): technical sales, functional and economic production, failure, customization, materials, reliability, performance, engineering, testing
  • Contemporaneous documentation and time tracking are not a requirement
  • Project approach method is not a requirement of capturing cost
  • Tooling application now includes– specification of tooling methods, technical details, productions process, manufacturing of samples of parts, execution of process to meet specification

Impact court memorandum: Suder vs. Commissioner of IRS

  1. Extending qualified supervision from direct supervision to highly paid executives;
  2. Rejecting the term and common argument of IRS that an activity is not qualified because of “routine engineering”;
  3. Confirms the allowance of engineers to apply their engineering knowledge to create the appropriateness of design; in other words, a process of experimentation can rely on existing principles of engineering;
  4. Confirms the qualification of a methodical product development process (e.g., Stage Gate), including market research of “general information on components” of a design;
  5. Allows for R&D time estimates to be prepared by a “C level” executive with direct knowledge of activities, and/or direct conversations of those who conduct such

Bottom line – the definition and qualifications of R&D has been simplified and expanded – routine engineering, process improvement, and executive compensation qualifies as an R&D activity and expenditure. Companies may be rewarded for routine development innovations.