Research & Development Tax Credits

June 21, 2011J ,

What are the biggest problemsWhat are the biggest problems facing quality professionals g q y p

today?

Research & Development Tax Credits

June 21, 2011J ,

Using research & development tax credits toUsing research & development tax credits to support funding for process/quality improvements

Introduction – About UsDavid DeMilleTax ManagerTax Manager

•Tax Return Services

•Business Tax Consulting

•R&D Tax ServicesM f t i•Manufacturing

•Computer hardware/software•Engineering & Design•Consumer products

ddemille@wsrp com (801) 328-2011

•Consumer products

ddemille@wsrp.com (801) 328-2011

Introduction – About Us

•Audit / Review / Compilation•BookkeepingQuickBooks Support•QuickBooks Support

•Business Valuation•Tax Planning & ConsultingIRS Representation•IRS Representation

•Tax Compliance•Mergers & AcquisitionsInternational Tax•International Tax

http://www wsrp com (801) 328-2011http://www.wsrp.com (801) 328-2011

Outline

Introduction Introduction Background

Qualifying for the credit Qualifying for the credit Calculating the credit Outlook

Background – History of R&D Credit

1981 Credit for Increasing Research Activities is created

1985 R&D credit expired

1986 – 2011 Credit is renewed annually by Congress

2001 “Di ” t t d fi d f bl f t2001 “Discovery” test defined more favorably for taxpayers

2010 Tax Relief…and Job Creation Act – AMT limit removed

2011 Ongoing discussion over making the credit permanent

What is the Research & Development Tax Credit?

F d l T C dit f I i R h A ti iti (IRC §41) Federal Tax Credit for Increasing Research Activities (IRC §41)

Credit is for “increasing” qualified research each year

Dollar for dollar reduction in tax liability

Non-refundable, but carries forward for 15 years

Incentive for U.S. companies to innovate and to create jobs

What Costs Qualify for the R&D Credit?

W Wages

Direct wages

Direct supervisory or support wages

Materials & Supplies

Contract Research (generally on 65% of contract research)

Misconceptions of the R&D Tax Credit

It’s only available for companies doing lab work

It’s only available for new inventions and groundbreaking

discoveries

The credit won’t help a start-up company

The government doesn’t want companies to claim the credit

What is Qualified Research?

New or improved business component – IRC §41(d)

Technological in nature – IRC §41(d)

Intended to eliminate uncertainty – Treas. Reg. §1.41-4(a)(3)

Process of experimentation – IRC §41(d)p § ( )

Taxpayer must retain benefits/burdens of ownership – Treas. Reg.

§1.41-4(c)(9)

Work performed in U.S.p

New or Improved Business Component

Product, process, computer software, technique, formula, or

invention

Must be held for sale, lease, or license, or used in the taxpayer’s

trade or business

New or improved component must be functional and not aesthetic

Not required to be successful

Technological in Nature

Fundamentally relies on principles of engineering, computer

science, physical or biological sciences

No requirement to exceed, expand, or refine common knowledge of

skilled professionals in a particular field – Treas. Reg. §1.41-4(a)(3)

Does not include

Research based on economic principles Research based on economic principles

Research based on behavioral, psychological, or other “soft” sciences

Intended to Eliminate Technical Uncertainty Uncertainty as to capability or method of developing or improving

business component, or appropriate design of component

Uncertainty for the following areas does not qualify by itself

Financial feasibility of development/improvement

Economic results of new/improved process/product

Appeal of certain designs

Employee acceptance of changes

Process of Experimentation

Evaluate one or more alternatives

Research alternatives

Iterative process (trial & error) Iterative process (trial & error)

Substantially all of the activities must constitute a process of

experimentation (80% of research activity being considered)

Benefits/Burdens of Ownership

Taxpayer must retain substantial ownership in new or improved

business component

Funded / Contract research performed by taxpayer do not qualify

for R&D Credit

R&D Tax Credits for Quality/Process Improvements New or Improved Business Componentp p

Continuous Improvement

Lean Manufacturing

Six Sigma

ISO 9001

Improvements to product quality, reliability, yieldp p q y, y, y

Increase manufacturing quality control

Supplier integration

Computer system integration

Green initiatives

Automation Automation

R&D Tax Credits for Quality/Process Improvements Technological in Nature could include the following:

Industrial / Process / Manufacturing Engineering

Quality Engineering

Statistical Analysis

Measurable Process Improvements

R&D Tax Credits for Quality/Process Improvements Intended to Eliminate Uncertainty

Uncertain if, how, or in what way quality improvement goals can be met

Uncertain how quality changes may affect manufacturing process

Uncertainty must relate to technical issues

R&D Tax Credits for Quality/Process Improvements Process of Experimentation

Research alternatives for a specific quality improvement goal

Implementation of new process improvement technique or system

Reconfiguration of plant operations

R&D ScenariosScenario 1Facts:Facts: Food manufacturer produces a large-shred version of product, and is seeking to

produce a fine-shred version of product. A smaller, thinner blade for the fine-shred is not commercially available. Company engages in trial and error process to analyze various blade designs and materials to develop fine-shredprocess to analyze various blade designs and materials to develop fine-shred blade.

Conclusion: Company’s activities qualify for the R&D credit, as they meet the four tests

New product Uncertainty Experimentationp Technological in nature

R&D ScenariosScenario 2Facts:Facts: Company has been having quality problems with widgets it manufactures.

Company is uncertain as to why product is failing. Company spends significant time analyzing production, and researching known issues regarding materials used in production Company discovers problem with machinery which isused in production. Company discovers problem with machinery, which is corrected with the purchase of a new piece of machinery.

Conclusion: Company’s activities do not qualify for R&D credit

Uncertainty and experimentation exist, however, the activities did not lead to a new or improved product or process

R&D ScenariosScenario 3Facts:Facts: Same as Scenario 2, except that rather than just replacing the machinery,

Company determines to investigate further improvement to manufacturing process. Company considers reconfiguring production system to improve efficiency Company researches alternative configurations and evaluatesefficiency. Company researches alternative configurations, and evaluates several approaches. Changes made by Company increase production output by 6%.

Conclusion: Company’s activities to discover problem with machine do not qualify for R&D

creditc ed Activities undertaken to improve manufacturing process do qualify for R&D

credit

Calculation of the Federal and State R&D Tax Credits Federal

Regular Credit – 20% of qualifying costs in excess of base amount (IRC

§41(a)(1))§41(a)(1))

Alternative Simplified Credit – 14%* of qualifying costs in excess of 50% of

lifi d h f i 3 t bl (IRC §41( )(5))average qualified research expenses for prior 3 taxable years (IRC §41(c)(5))

Credit may be claimed on prior returns for up to three years

*6% for first three years of eligibility

Calculation of the Federal and State R&D Tax Credits State

Many states offer R&D credits – some more generous than federal

R i t diff b t t Requirements differ by state

Utah – 5% of qualifying costs over base amount, and 9.2% of total qualifying

costs for 2010

Calculation of the Federal and State R&D Tax CreditsExample 1 p

Facts:

C XYZ $10 illi i i t f th l t 5Company XYZ averages $10 million in gross receipts for the last 5 years.

Qualifying research of $250,000 in 2008, $300,000 in 2009, and $350,000 in 2010

All research performed in Utah

Federal Credit Available: Up to $90,000

Utah State Credit Available: Up to $86,000

Total R&D Credit Available: Up to $176,000

Calculation of the Federal and State R&D Tax CreditsExample 2p

Facts:

St t C h i t i 1 100 000 i 2 d 600 000 i 3Startup Company has zero gross receipts in yr 1, 100,000 in yr 2, and 600,000 in yr 3.

Qualifying research of $60,000 in 2008, $65,000 in 2009, and $80,000 in 2010

All research performed in Utah

Federal Credit Available: Up to $20,000

Utah State Credit Available: Up to $19,000

Total R&D Credit Available: Up to $39,000

Calculation of the Federal and State R&D Tax CreditsExample 3p

Facts:

Mature company in business since 1980 doing R&D work but never claiming creditMature company in business since 1980, doing R&D work, but never claiming credit

Average gross receipts of $100 million for past 5 years

Qualifying research of $1.2 million each year during 2008, 2009, and 2010

All research performed in Utah

Federal Credit Available (Alternative Simplified Method): Up to $252,000

Utah State Credit Available: Up to $270,000

Total R&D Credit Available: Up to $522,000

Who is Claiming the R&D Tax Credit?

Industry 

Number of 

Returns 

R&E Credits Claimed [$1000s] 

fManufacturing  5,420 5,758,082Information  1,132 944,284Professional, scientific, and technical services  3,932 787,671Wholesale and retail trade  865 430,098Finance and insurance 237 142 599Finance and insurance  237 142,599Management of companies (holding companies)  276 62,091Utilities  129 48,855Various services  194 43,942Mining  36 29,997Administrative/ Support & waste mgmt. services  288 22,373Transportation and warehousing  58 10,593Construction  56 10,278Real estate, rental, and leasing  30 7,453A i lt f t fi hi d h ti 83 5 054Agriculture, forestry, fishing, and hunting  83 5,054

8,303,370

Source: Internal Revenue Service at http://www.irs.gov/taxstats/article/0,,id=164402,00.html 

Manufacturers Claiming the Credit

Industry 

Number of 

Returns 

R&E Credits Claimed [$1000s] 

Computer and electronic product manufacturing 1,319 1,812,225Chemical manufacturing 701 1,489,383Transportation equipment manufacturing 291 1,180,968Machinery manufacturing 651 339,851Miscellaneous manufacturing 575 279,958Electrical equipment, appliance, and component manufacturing 555 217,724Petroleum and coal products manufacturing 40 99 858Petroleum and coal products manufacturing 40 99,858Food manufacturing 163 80,719Fabricated metal product manufacturing 457 74,863Paper manufacturing 58 64,226Primary metal manufacturing 116 32,098Plastics and rubber manufacturing 202 31,366g ,Beverage and tobacco product manufacturing 18 12,844Nonmetallic mineral product manufacturing 70 12,283Furniture and related product manufacturing 70 11,240Textile mills and textile product mills 22 5,249Wood product manufacturing 14 5,016Printing and related support activities 38 4,417Apparel manufacturing 55 2,315Leather and allied product manufacturing 6 1,478

5,758,081Source: Internal Revenue Service at http://www.irs.gov/taxstats/article/0,,id=164402,00.html 

Opportunities – Quality & Process Improvement Prototype testing Production scalability testing Direct support of development Continuous Improvement Continuous Improvement

Lean Manufacturing Six Sigma ISO 9001

Improvements to product quality, reliability, yield Increase manufacturing quality control Supplier integration Supplier integration Computer system integration Green initiatives Automation

R&D Credits – Outlook

States moving towards increased benefits States moving towards increased benefits

Federal credit underutilized

Current federal budget proposal* Current federal budget proposal Increase the simplified credit rate by more than 20 percent

Make R&D credit permanent

http://www.treasury.gov/resource-center/tax-policy/Documents/Research%20and%20Experimentation%20report%20FINAL.PDF*

Contact InformationDavid DeMilleTax ManagerTax Manager

•Tax Return Services

•Business Tax Consulting

•R&D Tax ServicesM f t i•Manufacturing

•Computer hardware/software•Engineering & Design•Consumer products

ddemille@wsrp com (801) 328-2011

•Consumer products

ddemille@wsrp.com (801) 328-2011

Disclaimer

IRS Circular 230 Disclosure: To ensure compliance with prequirements imposed by the IRS, we inform you that, unless specifically indicated otherwise, any U.S. federal tax advice contained in this communication (includingtax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding

C ( )penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.y