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Benefiting from the R&E credit.

Companies involved in certain industries and processes may realize significant tax savings via the research and experimentation (R&E) credit, if they:

* Develop products and employ engineers or other technical personnel, either as employees or independent contractors;

* Dedicate resources to obtaining patents;

* Implement sophisticated software systems;

* Have product or product development teams that include personnel from throughout an organization; or

* Develop prototypes.

In today's competitive environment, organizations seek advantage through new products, manufacturing processes and computer technology that surpass both competitor's products and customer expectations.

As the cost of innovation increases, return on research investment becomes more difficult to reach. The R&E credit is a 20% incentive that can lower the cost of innovation. Maximizing the research tax credit results in lower tax bills, higher earnings and increased capital to support future innovation.

Recent Developments

Although Treasury issued final regulations in January 2001, it retracted them within a month; see Notice 2001-19, requesting further comments. On Dec. 13, 2001, the Service reissued proposed regulations, modifying the definition of qualified research.

Two issues are at the center of the debate over the final regulations. These are the appropriate level of documentation and the definition of "discovery."

Adding burdensome documentation procedures hinders the development process, compromising market competitiveness. However, some level of documentation should exist to record the process of experimentation and the intended results of the development activity. Companies often already possess acceptable documentation in the form of initial design specifications, and subsequent researcher notes contain the requisite information.

The proposed regulations eliminate the "discovery" test, which has been a difficult hurdle to clear in the past few years. They focus attention instead on clear definitions of "technical uncertainty" and "process of experimentation."

Overlooked Opportunities

Companies frequently incur qualified expenses beyond laboratories or product-development departments, yet fail to identify all these expenses and thus severely limit their R&E credit claims. Regardless of whether taxpayers have previously used the credit, understanding which costs are eligible, effectively documenting costs and implementing systems to track and report future costs can generate significant tax savings.

Tax savings may extend beyond the Federal research credit, as many states also offer research tax incentives. Additionally, the activities identified in connection with a research-tax-credit analysis may reveal other missed benefits, including reduced sales, use and property taxes, accelerated depreciation opportunities or reduced inventory capitalization.

The statute of limitations (SOL) for Federal income tax refunds allows taxpayers to amend returns for three years prior to the current year (four years for some states) to claim or increase the R&E credit and obtain refunds. The SOL may be extended for taxpayers who were subject to alternative minimum tax or who incurred net operating losses in prior years.


Now more than ever, taxpayers must keep abreast of developments in the research tax credit area. The proposed regulations are more taxpayer-friendly than before. Taxpayers should take advantage of this favorable environment to reevaluate whether they qualify for the credit.

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Article Details
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Title Annotation:research and experimentation tax credit
Author:Goldberg, Michael J.
Publication:The Tax Adviser
Geographic Code:1USA
Date:Feb 1, 2002
Previous Article:Substantially disproportionate redemptions.
Next Article:Calculating IRA distributions.

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