The following article was originally published in the Nov. 10, 2016, issue of the North Bay Business Journal.

The Research and Development Tax credit is a general business tax credit introduced in 1981 as a temporary credit to incentivize domestic research and job growth. At the end of 2015 the Protecting Americans from Tax Hikes (PATH) retroactively extended and made the popular R&D tax credit permanent, which could carry benefits to wine industry businesses.

Also included in the PATH Act were unexpected taxpayer-friendly incentives, such as beginning in 2016 eligible small businesses (i.e. those with $50 million or less in gross receipts) may claim the credit against alternative minimum tax liability, and the credit can be used by certain even smaller startup businesses against the employer’s Social Security portion of the payroll tax liability.

To determine whether or not your company qualifies for the R&D tax credit (IRS Revenue Code Sec. 41), you need to evaluate your research activities and determine if the activities meet this four-part test:

  1. Permitted Purpose: The purpose of the activity must create new or improve functionality, performance, reliability or quality of the business component. The business component can consist of any product, technique, process, formula or invention.
  2. Elimination of Uncertainty: The activity must be intended to discover information to eliminate uncertainty concerning the capability, methodology or appropriateness of design for developing or improving a product or process.
  3. Process of Experimentation: The taxpayer must engage in an evaluation process that is capable of identifying and evaluating one or more alternatives to achieve a result. This test may include modeling, simulation or systematic trial and error methodology.
  4. Technological in Nature: The activity performed must fundamentally rely on the principles of physical, biological, engineering or computer science. Examples of types of activities that may qualify include, but are not limited to, product development, feasibility studies, design/engineering testing, trial runs, product specification development, design for serviceability or usability, prototype development, beta testing and manufacturing process/design development. Likewise, examples of non-qualifying activities would include routine repairs & maintenance, adaptation, ongoing or routine production, training or administrative.

Once you\’92ve analyzed your activities and made a determination on the projects that qualify, the company needs to review the project expenditures to be sure they are eligible to be included in the calculation of the credit. A Qualified Research Expenditure (QRE) is the sum of the in-house and contract research expenses paid or incurred by the taxpayer during the taxable year in carrying on any trade or business of the taxpayer. QREs include:

  1. Taxable Wages: Personnel who are performing qualified activities related to direct research, direct supervision or direct support.
  2. Supplies: Tangible property other than land, land improvements or other property subject to depreciation that is consumed in the conduct or support of research. Examples include, but are not limited to, lab supplies, testing supplies and prototypes.
  3. Contract Research: Sixty-five percent of payments made to outside vendors/contractors for performance of qualified research service on behalf of the taxpayer. The “on behalf of” is refined by IRC Sec. 1.41-2(e) (3), which requires the taxpayer to have rights into the research results.

Once all of the projects and expenditures are identified it\’92s important to have and keep contemporaneous documentation for support of the calculation. The documentation is used to demonstrate that an activity meets the four-part test for qualification of the business component. Examples of documentation may include, but are not limited to, test results, research protocols, emails/reports regarding development or testing efforts, documentation describing research process, process flow charts, conceptual layouts, release comments to manufacturing for fabrication or build, material composition reports and trial run logs.

Is your company eligible for the R&D credit?

It depends on the stage of the company, but there are three different calculation methods in determining the tax benefit.In general the R&D credit is an incremental credit that equals 20 percent of the taxpayer’s excess QREs for the taxable year over their base amount. For tax years beginning after Dec. 31, 1989, the base amount is computed by multiplying the taxpayer’s fixed base percentage by its annual gross receipts for the preceding four years. The maximum fixed base percentage is 16 percent.

The taxpayer can elect to reduce the credit my making a 280c election on a timely filed return, which allows the deduction of the qualified research expenditures claimed for the R&D credit.

To learn more about this, and other related topics about the future of the wine industry, join us Dec 5 in person at the Marriott Napa Valley or via webcast. Take a look at this brief video to see what’s in store.