16 Aug Agricultural Activities Must Involve Qualified Research for the Federal R&D Tax Credit
Growers and producers in the agriculture industry that engage in research and development (R&D) activities can receive a federal tax credit for qualified expenses. These expenses include the salaries of employees involved in R&D, the wages paid to contractors or consultants hired to help with R&D, and the purchase of supplies that were used within the R&D process. Unlike the federal investment tax credit (ITC), the purchase and installation of a new piece of equipment does not qualify for the federal R&D credit unless the taxpayer uses it for qualified research.
What is “qualified research?”
Certain research is specifically excluded from the definition of “qualified research.” These activities include: (1) research conducted after the commercial production of the business component; (2) research related to the adaptation of an existing business component to a particular customer’s requirements or needs; and (3) research related to the duplication of an existing business component. These exclusions are generally intended to be the mirror opposite of qualified research because these activities fail one element of a four-part test, as defined below:
- Technological-in-nature: The R&D activity must rely on the principles of science, such as physics, chemistry, biology, computer science, or engineering.
- Permitted purpose: The purpose of the R&D activity must be to develop or improve a business product or process with regards to functionality, performance, quality, or reliability.
- Elimination of uncertainty: The purpose of the R&D activity must also be to discover information to eliminate technical uncertainty about the development or improvement of a product or process, i.e., the capability, methodology, or appropriateness of the business component design.
- Process of experimentation: Substantially all of the R&D activity must correspond to elements of a scientific process, i.e., evaluating alternative designs, testing hypotheses, trial and error testing, models and simulations, or other scientific methods for conducting experiments.
When can agricultural producers and growers claim the tax credit for qualified research?
The Protecting Americans from Tax Hikes (PATH) Act of 2015 made the federal R&D credit a permanent part of the Internal Revenue Code to enable taxpayers to plan long-term research projects in reliance on the tax incentive. This tax incentive is available to companies of all sizes and all stages of the revenue cycle. For example, many businesses with no tax liability can apply the credit against their payroll taxes, while small to mid-size business owners (earning less than $50 million in gross receipts) can apply the credit against their Alternative Minimum Tax (AMT) liability. Taxpayers need only document their expenses and make an election to claim the credit on the appropriate federal form. Best practice is to work with certified accounting, legal, and tax professionals to lower the risks of audit while maximizing the benefits of claiming the credit.
What if the research is related to the purchase of a new piece of equipment?
As stated above, R&D activities conducted “after the beginning of commercial production of a business component” are not considered qualified research for the federal R&D tax credit. These are activities that are conducted after the component is developed to the point where it is ready for commercial sale or use. For example, troubleshooting or correcting flaws in the business component are deemed to occur after the production of a business component and do not qualify for the R&D credit.
Are any other credits available?
The federal ITC permits taxpayers to deduct certain purchases that do not qualify for the federal R&D credit because the grower does not use the business component for qualified research. Solar technology, for example, is the primary equipment for which the ITC credit can be claimed. The solar property must be either constructed by the taxpayer or in its first year of service if otherwise acquired by the taxpayer. Any unused portion of the federal ITC can be carried forward if the purchaser’s initial tax liability is insufficient to absorb the full tax credit.
Likewise, several states offer special tax credits for purchasing and installing agricultural equipment, in addition to state R&D credits. For example, Maryland has a “Wineries and Vineyards Tax Credit,” which generally allows an individual or a corporation to claim a credit against its state income tax in an amount equal to 25% of the qualified capital expenses made for two purposes: (1) the establishment of new wineries or vineyards; or (2) the capital improvements made to existing wineries or vineyards. These unused credits can be carried forward for 15 years.
How can agricultural producers and growers properly claim the federal R&D tax credit?
If the R&D activities involve qualified research, then the taxpayer needs to document the agricultural activity in writing, including how any qualified research satisfies the four-part test, in addition to recording all of the taxpayer’s related expenses. While growers and producers in the agriculture industry should not be reluctant to claim credits to which they are entitled, the burden of proof is on the taxpayer to show that the claim was proper. This is especially important for documenting qualified research because the federal R&D credit can be carried forward up to 20 years. Thus, it is incumbent upon all taxpayers to keep their business records safe and organized for an extended period of time.