Research Activities Credit

What is the Research Activities Credit

The Research Activities Credit allows businesses and eligible entities to offset funds invested in certain research-related expenses through a reduction in their federal taxes.

Understanding the Research Activities Credit

The Research Activities Credit was implemented in 1981 and was intended to act as an incentive for companies and other entities to increase their research and development. The credit is available to individuals, estates, trusts, organizations, partnerships and corporations that pay for qualified research expenses conducted in the United States. Expenses can include wages, supplies, and a significant portion of funds paid to a third party to conduct qualified research (65 to 75 percent, depending on the type of entity hired). Partnerships and S Corporations must complete and submit IRS Form 6765 Credit for Increasing Research Activities to claim this credit. Others may claim it directly on IRS Form 3800, General Business Credit, except in cases where an estate or trust has the option to allocate the credit to beneficiaries. To see if you qualify for this credit, consult the IRS web site or a licensed tax professional.

Qualified research expenses must involve business-related technological experimentation involving the hard sciences (engineering, biology, computer science, etc.). The work must also seek to significantly enhance a product's function, performance, reliability, or quality. Additional rules apply to internal use software (IUS), which refers to computer programs not designed for sale, but to be used within a company to improve efficiency or other internal business functions. To qualify for the research activities credit, the software must offer the possibility of significant economic benefit through increased speed, reduced costs, etc.; its development must involve significant time, cost and risks; and nothing comparable can be available for sale or lease  Due to changes enacted in 2015, small businesses can apply this credit to reduce their Alternative Minimum Tax liability, and qualifying start-ups with no federal tax liability can apply it to payroll taxes up to $250,000 for a maximum of five years.

An Example of the Research Activities Credit

For an example, take the Pear Automotive Corporation. They make automobiles and related technologies. During the 2016 tax year they spent $500,000 on research and development. During this time, they came up with a brand-new idea for automobiles to come with global positioning tags. This will help family members track one another’s movements while they are on the road, decreasing the need to contact someone while they are driving. The same year, Pear Automotive Corporation also improved the design of their 2017 model sports utility vehicle, making the front end more visually appealing than the prior year’s version. The qualified expenses related to the development of the global positioning tags would qualify for the research activities credit, but those associated with changing a vehicle's look would not as the improvement is purely superficial.