In a competitive business environment, your company may be hard-pressed to keep up with the Joneses. Often, that requires sinking extra cash into research that may or may not result in profitable products.
Advice: Hedge your bets by taking advantage of the research-and-development (R&D) tax credit. It may surprise you to find that you qualify. The credit is a dollar-for-dollar reduction of taxes owed, not just a deduction. And many states offer similar research-tax-credit incentives.
Even better, the IRS just issued final regulations that clarify and relax some of the credit's complex requirements. (TDNR JS-1064) You can let your tax pro sift through all the intricacies of the new rules. But you should know the tax credit's basic premise and whether your R&D costs would qualify. Here's the deal:
What's a "qualified expense"? The credit covers four categories:
1. Wages for employees involved in research activities.
2. Research supply costs.
3. Payments to others for computer time used in qualified research.
4. Costs (65 percent) associated with contracting with an outside party to conduct research on your behalf.
You can claim the credit for regular salaries paid to some of your workers as well as specific research activities conducted outside the company. If an employee spends at least 80 percent of his or her time on research, his or her entire salary counts toward the credit.
For research costs to be "qualified expenses," they must be undertaken to discover technological information useful in the development of a new or improved business component. That may include research on new products, improvement of existing products, qualification testing, patent development and more.
The new IRS rules provide precise guidelines on which research qualifies.
How much is the research credit worth? The actual computation is quite complex. But, basically, the credit equals 20 percent of the increase in qualified R&D expenses over a "base amount," generally the annual average of those costs over the past four years.
So to claim the credit, you must increase your research activities in that year.
Example: If your 2003 R&D costs total $10,000 with a $4,000 base amount, your credit equals $1,200 (20 percent of $6,000).
How can you secure the credit? Claim the tax credit as one component of the general business credit on Form 6765, Credit for Increasing Research Activities. (Read the instructions at www.irs.gov/pub/irs-pdf/i6765.pdf.) The usual carry-back and carry-forward rules apply.
The credit expires July 1. We expect Congress to extend it, as it has done in the past. But to make sure, you may want to move up your R&D spending to the first half of 2004.