Looking ahead to next year’s tax season, you can maximize the benefits of available US tax credits and incentives. A powerful incentive known as the research and development (R&D) tax credit is available at federal and state levels to help companies recover a significant amount of their R&D costs.
Organizations that qualify for the credit range from small farming collectives investing in improved livestock breeding methods to pharmaceutical and medical device companies developing new products. The key factor is identifying research projects and activities and their related wages, supplies, and outside contractor costs to meet a four-part test under Section 41 of the US Internal Revenue Code.
This credit has been available since 1981, but the definition of qualified activities has changed significantly. In the past, the key barrier to the credit required that research be “revolutionary” in nature or advance the technical knowledge of a given industry. Now the requirement is merely that research activity be intended to discover technology information without regard to its significance for an industry as a whole. To assess a potential opportunity, contact tax professionals with expertise in your industry who can identify the qualifying activities, costs, and substantiation required to claim the credit.
Although many companies are capturing the R&D credit, many are not claiming all the credit to which they are entitled or are improperly including nonqualified costs. Here are several examples of companies that leveraged our expertise to obtain substantial tax savings.
Small Biomedical Device Developer
Do You Qualify? Large, publicly traded companies are not the only beneficiaries of the R&D tax credit. In educating a US$4 million regional biomedical device developer regarding which types of projects and employee activities qualified, we addressed this manufacturer’s misconceptions that R&D activities must be related to a revolutionary design that is new to the industry. The developer used extant technology to design and develop new and improved medical device products that met the requirements of specific applications, which qualified for the credit. A thorough analysis of the company’s projects and activities revealed ~$500,000 of net federal and state R&D tax credits. The refunds enabled it to hire additional engineers and purchase new equipment for research.
Biotechnology and New Drug Developer
How Do You Substantiate Your Claim? Are They Too Much? One pharmaceutical company identified millions of dollars in credits over several years that could not be claimed until it became profitable. Before using those credits, the client contacted us to determine the validity of its savings. We immediately discovered that a significant portion of the costs did not qualify: e.g., amounts for equipment, facilities, and indirect support personnel where entire departments were claimed. Ultimately, we identified significant missed cost savings. But most important, we protected the client from potential tax penalties in an exhaustive audit process by identifying relevant supporting documentation and determining which credits could be substantiated. This included analyzing and establishing a list of qualified projects and associated costs, including wages attributable to individuals based on recorded amounts of time spent on specific projects and the laboratory notebooks, test documentation, and other FDA documentation tying people to projects.
Generic Drug Developer
How Do You Qualify? Pharmaceutical companies’ drug development activities fit within almost every definition of R&D. Generic drug development involves taking an extant drug formulation and breaking down its components to determine a cheaper, better, or faster method of producing it. We worked with a generic drug developer that outsourced a significant portion of its chemical formulation and testing services to improve a drug formulation using cheaper excipients that enabled the end product to be stable in larger batch sizes for scaled-up production. Initially, we reviewed the client’s contracts with outside contractors and testing laboratories to evaluate the nature of the financial agreement and determine who retained rights to the research. Further, we reviewed the breakout of each generic formulation development task to exclude nonqualified costs in the credit calculation, identifying about a million dollars of net federal R&D tax credits invested in additional research chemists and equipment.
With more than 7,000 potential federal and state credit incentives, countless possibilities remain for unearthing additional tax savings.
Daniel Lewicki, PhD, and Walter Marvin are associate directors, and David Ji, MS, is head of the life science group and managing director of the Houston national office of alliantgroup, 400 Westheimer Court, #700, Houston, TX 77056-5354; 1-713-877-9600; www.alliantgroup.com.