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Research and Development Tax Incentives

By Jim Byman and John McNamara, McGladrey & Pullen

Many countries have research and development (R&D) tax incentives to drive productivity improvements and economic growth. Traditionally, the U.S. research tax credit has been scheduled to expire after a defined period of time, requiring periodic legislation voting to extend. The current credit is scheduled to expire Dec. 31, 2005. However, H.R. 1736 was introduced to the House of Representatives as a measure that would make the research credit permanent. Although it has bipartisan support, a permanent extension may not be passed due to budgetary pressures. It’s highly likely, though, that the research credit will be extended at least another year or two.

The U.S. research credit is based on a complex formula designed to reward incremental research above a base amount that relates to historical activity. It’s difficult to make such a system totally fair and ultimately some taxpayers who perform significant R&D don’t receive any benefit. But H.R. 1736 provides for a new alternative simplified credit to help correct this flaw.

Eligible costs include wages, supplies, and 65% of payments to outside contractors (incurred in the development of a new or improved business component). For these costs to be qualified for the credit they must meet with qualified research activities, which are:

  • Intended to discover information to eliminate uncertainty of capability, method, or appropriate design at the outset of the project;
  • Technological in nature, based on biological or physical sciences, engineering, or computer science;
  • For the purpose of improving function, performance, reliability, or quality;
  • Involving a process of experimentation, where one or more alternatives are evaluated and tested.

In addition, other qualifying activities include manufacturing process improvements and certain software development activities. Because of the restrictive interpretation the IRS applies to qualified activities, it’s important to establish processes to document the research activities and related qualified costs. Many manufacturing companies subcontract this activity to tax consultants who specialize in conducting R&D credit studies.

If you have any questions regarding research and development tax incentives, please contact either Jim Byman at [email protected] or John McNamara at [email protected].

McGladrey & Pullen and RSM McGladrey have over 100 US Offices, and member firms of RSM International have over 600 offices in 75 countries with more than 20,000 people worldwide. Locally, the New England area is served through our Burlington MA office, which specializes in the areas of manufacturing and distribution, construction and not-for-profit accounting.

(Reprinted with permission from Perspective — an RSM McGladrey publication.)


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