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Research and Development Tax Credit

At MEDOWS CPA, PLLC, our NYC Accountants can assist you in determining if you are eligible for a research & development (R&D) tax credit.

The expenditures of R&D are reasonable costs you incur in your trade or business for activities intended to provide information to help eliminate uncertainty about the development or improvement of a product. Uncertainty exists if the information available to you does not establish how to develop or improve a product or the appropriate design of a product. Whether expenditures qualify as R&D expenditures depends on the nature of the activity to which the expenditures relate. Neither the nature of the product (or improvement) being developed, nor the level of technological advancement matters when making this determination. The eligibility criteria for the research and development tax credit typically includes documented proof of a research project; receipts for equipment, supplies and related expenses; and some type of report on research progress. Suitable expenses for the R&D tax credit usually are restricted to equipment, supplies and consumables that are used directly to conduct research. Generally, the credit will be 20 percent of qualifying expenditures that exceed a base amount. The term ‘base amount’ is defined by multiplying the ‘fixed-base percentage’ by the average annual gross receipts of the taxpayer for the prior four taxable years.

Eligible Qualified Research Expenditures (“QRE’s”)

The costs eligible for the research credit as QREs must meet the definition of IRC § 174, which permits taxpayers to elect either to deduct “research or experimental expenditures” or to amortize the costs over a period of not less than 60 months. Those expenses are limited to:

  • In-house wages and supplies attributable to qualified research;
  • Certain time-sharing costs for computer use in qualified research; and
  • 65 percent of contract research expenses, that is, amounts paid to outside contractors in the U.S. for conducting qualified research on the taxpayer’s behalf.

To constitute qualified research:

  • The research must be undertaken for the purpose of discovering information that is technological in nature;
  • Substantially all of the research activities must constitute a process of experimentation; and
  • The experimentation must relate to a permitted purpose.

This definition is relatively broad and encompasses such activities as:

  • Developing new or improved products, processes or formulas;
  • Developing prototypes or models;
  • Developing or applying for patents;
  • Certification testing;
  • Developing new technology;
  • Environmental testing;
  • Developing or improving software technologies;
  • Building or improving manufacturing facilities; and
  • Streamlining internal processes.

Expenditures Not Included

R&D expenditures do not include expenditures for any of the following:

  • Quality control testing
  • Advertising or promotions
  • Consumer surveys
  • Efficiency surveys
  • Management studies
  • Research in connection with literary, historical, or similar projects
  • The acquisition of another’s patent, model, production, or process

The rules for software development are somewhat complicated, but one recent clarification states that if customized software is developed for sale or lease (not for internal purposes), then it is not subject to the extra hurdles of the High Threshold of Innovation Test. If a company develops internal use software, however, it may still qualify for the R&D Credit, providing that:

  • The software is innovative;
  • The development involved significant economic risk, and
  • A similar product is not commercially available.

If the above three criteria are met, then the cost of developing software for internal use may qualify for the R&D Credit. If any R&D Credits are discovered involving expenditures during the previous three years, you may amend the tax returns of the company or individuals in the case of flow-through entities.

If you feel that you may be able to take advantage of the Credit for Increasing Research Activities based on the information contained within, please let us know as our NYC Accountants would be happy to assist you.