Research and Development Tax Credit: Brewing Industry

Brewing companies perform daily research, not as a separate task, but as everyday improvement activity for their products. Thus, making this industry a strong contender for the Research and Development (R&D) Tax Credit.  Many companies are unware of this government incentive since there is a misconception that employees need to have a PhD or the research needs to be conducted in a state-of-the-art laboratory. Great news though, most of the products’ developments, improvements and testing are considered qualified research activities (QRAs) and thus fulfill the IRS Four-Part Test requirements which allows a company to claim the incentive.

The following activities conducted by brewing companies such as developing fermentation processes, filtration methodologies, bottling and canning processes, ingredient processing techniques, brewing and bottling equipment, and preservative chemicals are considered qualified research activities. Testing products to ensure consistency and shelf life are other brewery innovations that a company can claim for the R&D Tax Credit. Failures in the design, development or testing phase can also be considered QRAs, regardless of being catalogued as “failed projects”.  The IRS “failed project” provision is essential for companies in the brewery industry who constantly test products and some of them don’t meet the quality assurance threshold.

If your company conducts the activities explained above there is a strong likelihood that your company can take advantage of the R&D tax incentive. Visit the Kuhler Tax Credits website http://www.kuhler.com or email us at info@kuhler.com for more information on how we can increase your company’s market value and boost its bottom line through the Research and Development Tax Credit.

Research and Development Tax Credit: Agriculture & Farming

Many of the activities related to the agriculture and farming industry qualify for the Research and Development Tax Credit. Yet, business owners are unaware of this strategic financial planning tool given that, historically, the credit has been claimed mostly by manufacturing, pharmaceutical and software companies. Agricultural and farming companies continuously conduct qualified research activities (QRAs) and spend on qualified research expenses (QREs) such as identifying, testing and implementing new or improved agricultural and farming innovative solutions, which makes them a strong candidate for the Research and Development Tax Credit.

Given the nature of the agricultural and farming industry, businesses have the opportunity to constantly experiment with new products and processes. These opportunities present themselves on a daily basis, such as pest control, product development, cost efficient harvesting, water saving techniques, and specialty soil development. Other activities that can also qualify as QRAs are pesticide testing and evaluation, irrigation efficiency, and lighting improvement techniques.

Below you’ll find other farming and agricultural activities that will fulfill the IRS Four-Part Test and qualify for the Research and Development Tax Credit:

  • Packaging development
  • Reduce waste processes
  • Spoilage elimination processes
  • Increase in shelf life techniques
  • Feeding, breeding and crossbreeding techniques
  • Improved transportation methods

Does your company perform any of these activities? Drop us a line! To learn more about the Research and Development Tax Credit visit the Kuhler Tax Credits website www.kuhler.com or email us at info@kuhler.com

How Can Engineering Firms Benefit from the Research and Development Tax Credit?

Engineering firms are strong candidates for the Research and Development Tax Credit. Most of the activities they perform create new or improve existing business components (products, processes, techniques, inventions, formulas or software), the business components are technological in nature, they eliminate some kind of uncertainty, and they go through a process of experimentation. Engineering firm owners or their financial departments are unaware that expenses related to designing and testing may allow them to claim the valuable Research and Development (R&D) Tax Credit. These firms continue to underutilize this tax incentive due to the misconception that R&D can only be completed within a laboratory by an employee wearing a white coat.

In the civil engineering field, engineering and design activities related to road design, bridges, water and wastewater treatment facilities, foundation and earthwork, retaining walls and structures, site development and infrastructure often qualify for the Research and Development Tax Credit. These activities are strong contenders to claim the tax incentive since they are technological in nature and create new or improve existing processes and designs. Services relating to surveying, soil and material testing, traffic engineering, subsurface evaluation and landscape architecture typically will not qualify for the beneficial tax incentive. A simple change in the aesthetics of a landscape won’t fulfill the criterion of the IRS Four-Part test.

For example, in the environmental engineering realm, remediation design, solid waste system design, drainage system design and flare station design will qualify for the R&D tax credit given that they go through a process of experimentation and eliminate some kind of uncertainty. Furthermore, services relating to site assessment and investigation, permitting and regulatory compliance don’t qualify for the R&D tax incentive. The activities stated above do not identify and evaluate alternatives, perform trial and error experiments or test results, thus they aren’t considered as having a process of experimentation.

Does your company perform any of these activities? Drop us a line! To learn more about the Research and Development Tax Credit visit the Kuhler Tax Credits website www.kuhler.com or email us at info@kuhler.com

The Research and Development Tax Credit: Concept and Production

Several stages and activities are involved in the research and development of a product, process or service to create them. Some of these stages generally qualify as qualified research activities (QRAS), but others don’t meet the IRS Four-Part Test threshold.

As a recap, to meet the IRS Four-Part Test, an activity must meet all four items of the “Four-Part Test”. The IRS Four-Part Test requires a new or improved business component (product, process, technique, invention, formula or software), the business component to be technological in nature, some kind of elimination of uncertainty, and a process of experimentation.

As mentioned above, some activities within the research and development process are considered QRAs and qualify for the Research and Development Tax Credit and others don’t pass the threshold. The following production activities generally qualify as QRAs: concept development, applied research, design, prototype and first run tests. These activities can apply to a variety of industries such as: engineering, software and tech, environmental and life sciences, and manufacturing and design. The following production activities generally are considered non-qualifying: full production, life cycle management, sales and marketing.

The following industry examples will illustrate the QRA explanation made above. In the manufacturing industry, improvements to processes and quality and reduction of defects in a product are considered QRAs, whereas the management of these processes or products won’t surpass the IRS Four-Part Test threshold. Moreover, in the food industry, improvements to flavor emulations and testing ingredient replacements are considered a “process of experimentation”. On the other hand, the marketing and selling activities to promote this new product won’t be recognized as “technological in nature”.

Think your company’s expenses conducts qualified research activities? Send us an email at info@kuhler.com or visit the Kuhler Tax Credits website www.kuhler.com to learn more about the Research and Development Tax Credit.

Why Claim the Research and Development (R&D) Tax Credit?

Tax season is quickly coming to an end and here at Kuhler Tax Credits we are wrapping up all of our Research and Development Tax Credit studies that need to be filed before the April 15 deadline. That is why the Kuhler team wants to remind you the importance of claiming the R&D Tax Credit. The purpose of this incentive is to encourage U.S. businesses to develop new products, services and systems as well as to stimulate the economy and provide jobs. It is the government’s way of rewarding businesses with a federal and state (most of them) reduction in current and future company tax liabilities.

The R&D Tax Credit allows a company to recapture a percentage of the dollars spent on R&D. The recapturing of these dollars assist companies in reinvesting the money back into the core business operations and remain competitive in their market field. The R&D Tax Credit is one of the most valuable tax incentives available to companies performing qualified research activities (QRAs) and qualified research expenses (QREs) in the U.S.

The R&D Tax Credit isn’t an income tax deduction but an actual dollar-for-dollar reduction against the taxes currently owed and taxes previously paid by a company. Companies can claim the R&D Tax Credit for all open tax years. A company can potentially receive a refund check for taxes paid for QRA in previous years from the IRS and state tax authorities. More importantly, the federal R&D Tax Credit can be carried forward for 20 years.

President Obama signed the Tax Extender bill into law in December 2015 making the Research and Development Tax Credit permanent. Given the new set of regulations, we project that the R&D Tax Credit benefit will nearly double for our clients in 2016!

Research and Development Tax Credit: Chemicals and Plastics

The chemical and plastics industry is a strong contender for the Research and Development (R&D) tax incentive. However, many companies are unacquainted with the scope of the benefit and don’t take full advantage of it. In recent years, the IRS has broadened the spectrum as to what qualifies as research and development and thus companies should take a second look at this strategic financial opportunity. Companies in the chemical and plastic industry need to not only look into the R&D department, but every other department since not all qualifying R&D activities take place in traditional R&D laboratories. Many individuals involved in the R&D activities may not necessarily work at a laboratory or in a chemist group and consequently are overlooked for R&D tax credit purposes.

Most of the activities conducted in chemical or plastic companies involve extensive experimentation and testing to ensure product quality and process efficiency. The following are some common practices within the industry: formula, method and process development, scale-up processes, and analytical testing of experimental or improved products. These activities will definitely fulfill the IRS Four-Part test and thus are considered qualified research activities (QRAs).

The following are examples of plastic injection molding activities that are eligible for the R&D tax credit study:

  • Mold and tooling – design, prototyping, fabrication and testing.
  • Engineering and process development.
  • Material application, temperature, pack and hold, and gate seal study.

The following are examples of chemistry innovations eligible for the R&D tax credit study:

  • Development of new testing methods.
  • Designing new drugs and chemical compounds.
  • Conducting tests to satisfy regulatory requirements.
  • Developing devices for testing.
  • Developing new applications for existing chemicals.

If your company conducts activities within the chemical, oil and gas, polymer, and pharmaceutical industry there is a strong likelihood that your company can take advantage of the R&D tax incentive.

Qualified Research Expenses: Substantiation and Recordkeeping

IRS regulations state that “a taxpayer must retain records in sufficient usable form and detail to substantiate that the expenditures claimed are eligible for the credit.” The taxpayer has to fully comply with this regulation when collecting all the information needed for an audit. The IRS states that if a taxpayer fails to maintain the records, they can disallow the Research and Development Tax Credit.

The IRS doesn’t have to accept qualified research expenses (QREs) estimates if the necessary documentation to verify the expenses exist. They will accept estimates if there are no contemporaneous records and two conditions are satisfied:

  • The taxpayer established performance of qualified research activities (QRAs) as defined in section 41(d).
  • The failure to maintain a proper recordkeeping system cannot be an inexactitude of their making.

The taxpayer must have evidence that can support every assumption made to meet the IRS guideline’s burden of proof.

The IRS guidelines state that the initial audit document request should be files that are readily available to the taxpayer. The following are some examples of initial requested documents:

  • Taxpayer’s base amount and fixed base percentage calculations.
  • General information: Chart of accounts or organization charts.
  • Acquisitions and dispositions from 1984 through the tax year under audit.
  • Accounting method: Are costs accumulated by department or by project?
  • Activities: What are they and why are they eligible for the R&D credit?
  • Wages: Names, amounts, percentages of annual wages, departments, job titles and descriptions.
  • Supplies: Categories, how they tie into the general ledger, and amounts.
  • Contracts: With whom, amounts, and categories.

The IRS might also ask for information that will help understand the acquisition of company resources or details about research projects conducted within the examination year. The following are some examples:

  • Materials explaining research activities, i.e. brochures, pamphlets, press releases, etc.
  • Submissions to management, the board of directors, review committees, etc.
  • Documents prepared by or on behalf of the internal audit.
  • Minutes or notes from budget, board of directors or managerial meetings.
  • Project authorizations, budgets, or work orders that initiate a research project.
  • The internal authorization policies for approving a research project.
  • Project summaries and/or progress reports and project meeting minutes.
  • Field and lab verification/summary data.
  • Research credit studies conducted by outside consultants.
  • Paper, treatises, or other published documents regarding the taxpayer’s research.
  • Complete copies of contracts, letter agreements, memoranda of understanding, or similar documents for research performed by, or on behalf of, a third party.

Additionally, an oral testimony by an individual with personal knowledge about the research projects will supplement a taxpayer’s contemporaneous documentation.

To survive an IRS audit, taxpayers are required to keep records that substantiate any expenses reported or claimed. Thus, they have to clearly establish full compliance with all IRS regulatory requirements.

The Consistency Rule

In addition to the IRS requirements and guidelines for the R&D tax credit, the IRS also requires the “consistency rule” be used as a basis to request and collect financial and technical information for current and open tax years. The “consistency rule” states that the qualified research expenses (QREs) that are taken into account to compute the base amount should be determined consistently with the QREs used to calculate the credit. This rule avoids an overstatement or understatement of the R&D tax credit by not allowing manipulation of the base years’ QREs.

Under Section 41(c)(5)(A), the “consistency rule” states, that in order to “accurately calculate a credit, the taxpayer is required to define qualified research expenditures the same from year to year.” The IRS adds that the taxpayer must show consistency between the QREs in the credit year and the QREs in the base year. The gross receipts in the base years also have to agree with the prior four years’ average.

This rule is designed to ensure accuracy in the determination of the increase in QREs over the amount regularly spent by the taxpayer relative to its gross receipts. The Research and Development tax credit is an incremental credit, thus, the taxpayer has to prove there has been an increase in QREs relative to its base period. Taxpayers can’t rely on an estimate to support the calculation of the fixed-based percentage. Thus, base year records should be analyzed to determine the correct amount of expenses.

The IRS recommends asking the following questions to make sure, as a taxpayer, you abide by the consistency rule:

  • Is the fixed-base percentage in the base years substantially lower than the current research ratios? If so, why?
  • Do past annual reports or 10Ks support the reported base years’ QREs?
  • If the research credit was claimed in prior years, were the same base years’ attributes used? If not, why not?
  • Was there a prior research credit examination? Did it cover one or more of the base years?

If the IRS believes there isn’t sufficient evidence to prove the claimed qualified research activities (QRAs) and QREs, it will disallow that portion of the credit calculation. Therefore, it is important to properly map out responses to not only the consistency rule, but also substantiate and record keep your expenses with your tax credit providers. We will go into substantiation and recordkeeping next week.

Research and Development Tax Credit: Funded Research

Contracts matter to the IRS, so it is important to take a closer look at funded research and what it means to the Research and Development Tax Credit. Research expenses are considered funded if they are compensated by grants, contracts, persons or government entities. To be eligible for the R&D tax credit, the research can’t be funded by a third party unless it meets the two-part test set out by Treasury regulations.

The Treasury Regulation Section 1.41-4A(d) outlines two requirements for determining whether research is funded and whether it will qualify for the R&D Tax Credit. The regulation states that if payments are received from others, the activities qualify only if:

  • The researcher bears the financial risk for their research in the project
  • The researcher retains substantial rights in the research project

Bears the Financial Risk

A researcher bears the financial risk for the research if payment is contingent on the success of the research. Payment is considered to be contingent on the success of the research if the payment is for the product to be created or result to be provided as a result of the research. The idea is that if the research were to fail, the researcher wouldn’t be able to deliver the product or result and, therefore, it wouldn’t be entitled to payment.

Retain Substantial Rights

Research is treated as fully funded if the taxpayer enters into an agreement to perform research and pursuant to the agreement doesn’t retain “substantial rights in the research”. The right to use the product of the research in the taxpayer’s trade or business without paying licensing fees or royalties has been determined to be a substantial right. Researcher retains substantial rights if it retains the know-how of the research.

If your company fulfills the two requirements outlined by Treasury Regulation Section 1.41-4A(d) visit the Kuhler Tax Credits website www.kuhler.com or email us at info@kuhler.com for more information on how we can increase your company’s market value and boost its bottom line through the Research and Development Tax Credit

Research and Development Tax Credit: Contract Research

The IRS defines Qualified Research Expenses (QREs) as the sum of “in-house research expenses” and “contract research expenses”. Those in-house research expenses include:

  • Wages: Taxable or subject to self-employment tax of individuals performing, directly supervising or supporting the qualified research.
  • Supplies: Amount paid or incurred for materials used in the conduct of qualified research.
  • Contract Research: Payments for the conduct of research. The taxpayer must be at risk when conducting the research.The IRS defines a contract research expense as 65% of any expense paid for the performance of qualified research on behalf of the taxpayer. The IRS provides a three-part test that determines what is considered a contract research expense. The contract research agreement with a third party.

Contract Research

  1. Must be agreed on prior to the performance of the qualified research.

The taxpayer and the contracted party must have an agreement before the performance of the qualified research commences. The IRS states that only 65% of the contract research expense may be eligible for the Research and Development Tax Credit calculation.

2. States that the research is being performed on the taxpayer’s behalf.

The taxpayer must retain the rights of the research being performed. The taxpayer retains the rights if it retains the know-how of the conducted research. This means that the taxpayer will be able to use the product of the research without paying any licensing fees or royalties to the third party contracted.

3. Requires the taxpayer to bear the expense of any risk involved with the research.

The taxpayer bears the financial risk for the research if payment is not contingent on the success of the research. The taxpayer must bear the cost even if the research isn’t successful. Payment is considered to be contingent on the success of the research if the payment for the contracted party is for the product to be created or result to be provided as a result of the research. Thus, if the research were to fail the taxpayer bears the expense of any risk involved with the research.

Think your company’s contracted research meets these requirements? Send us an email at info@kuhler.com or visit the Kuhler Tax Credits website www.kuhler.com for more information on how we can increase your company’s market value and boost its bottom line through the Research and Development Tax Credit.