Staying competitive requires companies to continually develop and improve products and processes—making robust research and development (R&D) programs the driving force behind growth for many businesses. The U.S. government realized the importance of R&D to the economy decades ago, prompting the enactment of §41 of the tax code in 1981. After decades as a temporary incentive, the R&D tax credit was made permanent in December 2015 with the Protecting Americans from Tax Hikes (PATH) Act. The PATH Act also enhanced other areas of the credit pertaining to start-up companies and eligible small businesses.
A company’s overall R&D spend can be significant. The ratio of R&D to total sales, also referred to as R&D intensity, typically runs anywhere from 3 percent to more than 40 percent. Smaller companies in certain industries such as biotech or software may have significantly higher ratios, so company size is not necessarily a determining factor when evaluating R&D.
Many companies conduct R&D activities as part of their daily operations but may not realize it. Nor do they realize that both federal and state R&D tax credits are available to help offset the costs associated with research. The federal R&D tax credit reduces past, current and future years’ federal tax liabilities and is an actual dollar-for-dollar offset against taxes owed or paid—creating an immediate source of cash that companies can reinvest into the business. As a wage-based credit, salaries and wages paid to employees or contractors for conducting specific activities as well as supply costs qualify for R&D tax credits.