Don’t overlook the variety of activities that can qualify for the R&D credit
Health care is one of the industries most likely to benefit from the federal research tax credit, or R&D tax credit, which is designed to reward companies for increasing investments in research and development. Yet, many health care companies don’t realize they may qualify.
This dollar-for-dollar offset of federal income or payroll taxes paid or owed can potentially save a health care organization thousands of dollars. It can be applied in a variety of ways, including to future and past income tax liabilities and, for some startups, to payroll taxes.
First enacted by Congress in 1981, the credit for Increasing Research Activities, commonly known as the R&D tax credit or research tax credit, is a federal tax incentive for businesses to increase their investments in research and development. Under Section 41 of the Internal Revenue Code, the credit allows qualifying taxpayers to reduce their tax liability based on their annual Qualified Research Expenses (QREs). QREs include certain expenses paid or incurred while conducting Qualified Research Activities (QRAs).
Generally, the federal research tax credit is used to offset federal income taxes owed by the entity paying or incurring the Qualified Research Expenses. In the absence of tax liability, a taxpayer can generally carry-forward the credit for future utilization (up to 20 years). The credit can also be carried backward for one year. Corporations (C-corps) can transfer unused R&D tax credit to a buyer in the context of a sale or exit; this is subject to certain limitations. Certain startups can use their R&D Tax Credit against their share of payroll taxes, providing an immediate benefit even if they are still not taxable from a federal income standpoint.
For health care businesses that may qualify, it’s important to keep good records and understand exactly which expenses you can receive a tax credit for. You'll need to demonstrate how your activities meet the criteria for the credit. Documentation should include project descriptions, project timelines, technical design documents, and financial records related to R&D expenditures.
It is critical to document and substantiate when the research and development begins and ends, as it can have a major influence on the size of a research tax credit claim. A tax professional with R&D tax credit expertise can help you understand these parameters under the tax rules and make sure the proper documentation is created and retained.
Contrary to some misconceptions, a wide range of activities are considered Qualified Research Activities and may be eligible for use in claiming the research tax credit. In fact, eligibility for the credit is not limited to basic research, new product development, or laboratory research. It also includes many activities relating to the improvement or enhancement of existing products, software, or manufacturing and transformation processes.
Examples of health care-related activities that could qualify for the research tax credit include developing new or enhanced:
Examples of pharmaceutical activities that might qualify for the research tax credit:
R&D expenses that might qualify include:
Taking advantage of the federal R&D tax credit can significantly reduce the cost of research and development activities for health care organizations, allowing them to allocate more resources to innovation and improving patient care. However, it's essential to consult with tax professionals who specialize in this area to confirm compliance and maximize the benefits.
Substantiation of the R&D tax credit constitutes one of the most challenging issues for many taxpayers -- but that should not deter businesses from exploring whether they can claim this lucrative credit.
Health care organizations should be proactive about consulting with their tax advisors about the R&D tax credit may benefit their business.
Louis Guay is Principal, R&D Tax and Cost Segregation Services, in the Boca Raton office of Kaufman Rossin. Lindsay Kaiser is Manager, R&D Tax and Cost Segregation Services, in the Boca Raton office of Kaufman Rossin.