R&D credit claims hit all-time high across industries

Manufacturing Growth InnovationThe IRS has released new statistics showing dramatic growth in R&D credit claims, thanks to an improving economy and favorable new guidance. The newly released figures for 2012 depict the IRS’s most up-to-date picture of the R&D credit landscape, showing the following:

  • The alternative simplified credit (ASC) is more popular than ever.
  • Businesses with less than $10 million are responsible for more than half the claims.
  • Both total claims and average claim amounts are up across all industries.

Total R&D credit claims topped $11 billion in 2012, up from $9.5 billion a year earlier. ASC claims now represent more than two-thirds of total R&D credit claims, up from just 59% in 2011. The total number of companies claiming reached 15,873 for the first time, an increase of 8.2%. In addition, the average claim grew 7.8%, from $645,000 in 2011 to $694,000 in 2012.

The sources of claims are beyond the largest companies and expected industries. Just over 51% came from businesses with less than $10 million in gross receipts. And while manufacturers still represent the biggest users, many other industries not as commonly associated with the credit are also benefiting. The following are total annual credit claims by industry.

  • Manufacturing --  $6.7 billion
  • Information technology -- $1.8 billion
  • Professional and technical services -- $1.1 billion
  • Retail and wholesalers -- $775 million
  • Finance -- $265 million
  • Mining -- $80 million
  • Utilities -- $52 million
  • Real estate -- $28 million
  • Construction -- $25 million
  • Transportation and warehousing -- $21 million

The skyrocketing claims are driven both by the improving economy and favorable guidance over the past several years. Additional guidance developments over the past year have created even more favorable rules and should push claims higher in 2014 and 2015. These developments have the potential to do the following:

  • Allow the ASC to be claimed on amended returns
  • Expand the kinds of internal use software that may qualify
  • Allow more executive compensation to be claimed as qualified wages
  • Soften the rules on when “routine” research qualifies

Alternative simplified credits The IRS recently finalized regulations that offer taxpayers a new opportunity to claim the ASC on an amended return. The ASC is an alternative to the traditional R&D credit that offers a 14% credit and relies on only three years of data. Companies are now permitted to claim the ASC on an amended return, but the opportunity is only for open years in which no research credit was previously claimed. Taxpayers that claimed a traditional research credit cannot now amend to claim the ASC. The regulations provide a tremendous opportunity for anyone who performed a study that found no opportunity for the traditional research credit in a prior year but may still qualify for the ASC.

Internal use software The IRS recently proposed new regulations that would enable companies to claim R&D credits on software that previously would have been excluded under the internal use software rules. The R&D credit is generally not available for internal use software, but the proposed regulations include three important exceptions:

  1. Software that enables a company to interact with third parties or allows third parties to initiate functions or review data on a company’s own system may qualify.
  2. A company can segregate dual-use software to claim a credit on the portion intended for third-party use, and a new safe harbor allows a partial credit even if a company can’t identify specific third-party elements (as long as at least 10% of the function is for third parties).
  3. Internal use software that meets a higher threshold for innovation than required under the normal credit can still qualify.

Although the proposed regulations haven’t been finalized, you can generally rely on them beginning with the 2015 tax year.

Tax Court determinations The Tax Court delivered a recent opinion in Suder v. Commissioner (T.C. Memo 2014-201), which offers important guidance regarding what constitutes “qualified research” and the type of compensation that can be included in expenses. It should offer taxpayers new opportunities and strengthen many claims. The court rejected two common IRS arguments and held the following:

  • “Routine” research can qualify.
  • Executive employee wages can be included.

The court held that 75% of the CEO’s time spent on qualifying R&D was a reasonable allocation and that R&D credit tests don’t necessarily require taxpayers to “reinvent the wheel.” However, the decision also reinforces that to substantiate credits, a company must have credible witnesses that have personal or close knowledge of the relevant facts and present solid, substantiating evidence.

Mark Andrus
+1 503 276 5910

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