R&D tax credits can present a great opportunity for a dollar-for-dollar reduction in your federal and state income tax liabilities, reduction of your effective tax rate and increased cash flow.
In the 1960’s, U.S. productivity was down for the first time. By the 1970’s, we were losing our competitiveness. In 1981, the credit was introduced as part of the Economic Recovery Tax Act. The intent was to incentivize companies to discover new products, processes, techniques, formulas, inventions and technologies. It became a very transformative period of time especially in the area of information and communications. We could now watch news 24 hours each day, leave a voicemail and fax a proposal in minutes. The distribution of information was flowing faster than ever. The U.S. was a giant think tank again and we were flourishing with great innovations. And if you were developing, designing or manufacturing these cool, groundbreaking new things, you were rewarded with the R&D tax credits.
Then the 90’s rolled around and other countries offered to do the same work for a lot cheaper. Competing in this new worldwide marketplace was becoming difficult for companies performing their technical work in the U.S. Taking the R&D tax credit could help to offset the significant costs between performing your technical work in the U.S. vs overseas. Smaller and middle market companies hoping to benefit from any commercial advantage available ultimately applied for the R&D credit.
The IRS proposed that the research needed to discover new information that exceeded or expanded the common knowledge of other skilled professionals in their field. The statute lacked clarity, it didn’t state whether such research activities had to be groundbreaking or new to your particular industry. Consequently, this led to significant confusion amongst taxpayers.
With U.S. competitiveness in steep decline, there was pressure on the IRS to issue new regulations. Proposed regulations were issued in December of 2001. The regulations did not include the requirement that qualified research seek to expand the knowledge of the world.
Hooooray! Now, your design, development or manufacturing activities only had to be new to you and performed in the U.S. Most viewed this as an attempt by the IRS to finally adhere to Congressional intent with respect to incentivizing companies to produce more ideas, innovation and technologies by lowering the cost of these activities. While this may not entirely offset the cheaper alternative overseas it does help level the playing field.