Private companies in almost any industry can benefit from federal and state tax credits for research and development (R&D) projects, which can help offset the cost of innovation activities and reserve cash to fund future innovation activities.
Francois Chadwick, partner in KPMG’s Federal Tax practice, says most mature private companies that are profitable, and therefore taxable, are probably taking the R&D tax credit already. However, entrepreneurial ventures and growth stage companies that are moving from losses to potential profits should be considering what steps they need to take to qualify for these credits. This can also be a strong benefit for private companies with goals to go public or hoping to be acquired. It is important companies fully understand the requirements for these credits so that their claims can be defended upon audit and they are properly identifying all potential credits for which they may be eligible
Meeting the requirements
To claim the credit, privately-backed companies must generally qualify R&D activities against a four-part test in the tax code. At a high level, qualifying research must satisfy the following;
For example, to satisfy the requirement “consists of a process of experimentation”, a software business could show evidence of its beta testing process, minutes from programming meetings, or status reports from programmers to executives. After identifying qualified R&D activities, the business must then quantify expenses related to those projects.
“The taxpayer needs to supply the IRS with extensive documentation to start using the credit and to keep the credit if they’re audited,” Chadwick says. “They generally need to find documentation that was created during the time of the project that truly shows the project passes all parts of the test.” However, credible oral testimony can also be used to support a research credit claim.
In addition, certain internal-use software (generally defined as software that is not being held for commercial sale, lease or license to third parties and software that is not designed to provide computer services to customers) can also qualify for the credit if it meets three additional tests: