Why Extending R&D Credit Should Matter to Small Businesses

The chances of the now-expired business research and development (R&D) tax credit being revived before the midterm congressional elections in November are pretty slim.

A bill to extend the R&D credit – along with some 50 other tax breaks that expired at the end of 2013 – for two years has stalled in the Senate over a disagreement between Democrats and Republicans over amendments. The full House of Representatives already passed a bill early last month that would extend the R&D credit permanently, but the Obama administration threatened to veto the legislation because the estimated $156 million cost to revive the credit would not be offset.

If the Senate does pass its bill later this year, Congress will then have to determine which proposal will ultimately become law.

But despite the R&D credit’s current uncertainty in Congress, experts say that small business owners should continue to pay attention to lawmakers’ discussions because of the tax provisions each bill could provide their companies once a compromise is reached.

For example, under the House legislation, the rate of the Alternative Simplified Credit (ASC) – another method used to compute the R&D tax credit – would increase from 14 percent to 20 percent, while the Senate proposal would allow small business owners to take the R&D credit against their alternative minimum tax (AMT) liability.

“My view is that regardless of whether the R&D tax credit is made permanent, the better priority is to make it more accessible for small and medium businesses, and fortunately, that is what the Senate and the House have both done,” Dean Zerbe, national managing director of Houston-based specialty tax service provider alliantgroup, told AccountingWEB.

Criteria of Four-Part Test

According to David Wong and Chad Paul, senior directors of R&D tax services at BDO USA LLP, small businesses could qualify for the R&D tax credit if their research activities meet the following four-part test:

  1. The research is intended to develop a new or improved “business component” – product, process, software, technique, invention, or formula – with regard to its functionality, performance, reliability, or quality.
  2. The research is developed through a process in which substantially all of the activities constitute elements of a process of experimentation.
  3. The research fundamentally relies on technological principles, such as those of engineering or the physical, biological, or computer sciences.
  4. The research eliminates uncertainty regarding either the taxpayer’s capability of or method for developing or improving the business component – or the component’s appropriate design.

The R&D credit is provided as an incentive for US companies to make bold investments in developing new technologies. As David Wong, a senior director of R&D tax services at accounting firm BDO USA LLP, told AccountingWEB, “These attempts may fail, or they may result in the next great American innovation.”

Based on the most recent IRS data, nearly 13,000 companies claimed $8.5 billion worth of R&D credits in 2010. Of that $8.5 billion, $7 billion was claimed by corporations with more than $250 million in business receipts.

Wong said companies of all sizes can claim the credit, as long as they are "engaged in qualified research activities, and the amount is very much related to the amount of expense incurred."

Companies may be able to claim the credit provided that they are conducting research in the United States and if their qualified research activities meet the criteria of a four-part test (see sidebar).

“As a result, by virtue of their size, large companies receive the majority of credits claimed," Wong said. "Large companies also have the advantage of being able to allocate more resources to better scope the opportunity, identify the qualified expenses, and document qualified activities.

“With that said, small businesses seem to be more appreciative of the credit,” he continued. “Small businesses typically have very engaged owners and employees, and any assistance they can get to grow their business is welcomed.”

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