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The research and development (R&D) tax credit is one of the most significant domestic tax credits remaining under current tax law. Savvy corporate tax teams can use this important tool to implement federal tax planning strategies that maximize their company’s value.
However, the tax issues around R&D investment and acquisitions are not trivial. They are complex, and like many other aspects of corporate tax planning, require forethought and analysis to guide the business in making the right tax-optimized decisions.
What are R&D tax credits and deductions?
Congress created two important incentives for a business to invest in research activities in the United States:
- The ability to elect to deduct such expenditures currently (I.R.C. §174)
- The permanent ability to claim a credit for increasing research expenditures (I.R.C. §41)
Eligible research costs include those paid or incurred for research conducted by the taxpayer as well as research conducted on the taxpayer’s behalf.
Current deduction or five-year amortization of R&D costs
In 1954, Congress enacted I.R.C. §174, allowing taxpayers, for expenditures incurred after Dec. 31, 1953, to either:
- Currently deduct research or experimental expenditures paid or incurred “in connection with” a present or future trade or business
- Elect to amortize R&D costs over a period of not less than five years
The purpose of I.R.C. §174 was to encourage taxpayers to carry on research and experimental expenditures by eliminating the uncertainty concerning the tax treatment of these expenditures. Research and experimentation are basic activities that must precede the development and application to production of new techniques and equipment, as well as the development and manufacture of new products.
Permanent tax credit for increased R&D spending
In 1981, concerned that spending for these activities was not adequate and was in fact declining, Congress enacted a nonrefundable income tax credit for incremental research and experimental expenditures to overcome the reluctance of companies to bear the significant staffing and supply costs to conduct research programs in a trade or business. The credit is incremental in nature to encourage enlarged research efforts by companies that already may be engaged in some research activities. I.R.C. §41 was made a permanent provision of the Internal Revenue Code as part of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act).
