Estimated at more than $12 billion annually, the research and development (R&D) tax credit is one of the biggest tax incentives available to businesses. The potential tax savings for wineries could be in the hundreds of thousands of dollars. However, many Californian wineries are missing out, with some completely unaware of the credit’s existence.
Wineries that fail to realize the maximum benefits of the R&D tax credit often do so because of a lack of understanding about what activities qualify as research, what expenditures qualify and what documentation is required to substantiate their claims.
Can you use this credit?
Understanding what classifies as qualified research is the starting point for any company looking to claim the credit. Eligibility can often quickly and easily be estimated by answering simple questions in the IRS’ four-part test:
1. Elimination of uncertainty. You must demonstrate that you’ve attempted to eliminate uncertainty about the development or improvement of a product or process.
2. Process of experimentation. You must demonstrate — through modeling, simulation, systematic trial and error, or other methods — that you’ve evaluated alternatives for achieving the desired result.
3. Technological in nature. The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology and/or computer science.
4. Qualified purpose. The purpose of the research must be to create a new or improved product or process, resulting in increased performance, function, reliability or quality.
Documenting activities and expenses
Eligible expenses for the R&D tax credit are wages (as reported on Form W-2, box 1), supplies used in the research process, and contractor expenses that would be eligible if the same services were performed in-house.
After identifying qualified research, it’s critical to document the activities and demonstrate a connection between your qualified activities and your eligible expenses. The importance of this documentation cannot be overstated. Accurately tracking qualified activities and their related expenses can help your company realize the full benefit of the R&D tax credit.
Your company may already be documenting its R&D efforts, in which case it may just be a matter of improving the records you keep or making adjustments to your documentation processes to ensure that you capture the records necessary to properly support the tax credit.
Examples could include project notes, lab reports, emails or other documents that help demonstrate how your activities meet the four-part test.
Using the R&D tax credit
Companies that are not currently taxable should still take advantage of the R&D tax credit, since the federal credit can be carried back one year and forward 20 years. And many state R&D tax credit programs also have lengthy carry forward provisions.
Certain elections must be made on your tax returns, and it’s much easier to collect documentation and support for credits identified and claimed contemporaneously than to look back and do so historically. Recently, the R&D credit was enhanced and made permanent.
One enhancement allows eligible small businesses to use their credits to offset the alternative minimum tax, and another allows qualified small businesses to use up to $250,000 in credits against their payroll taxes. Both enhancements are a windfall for companies and business owners who haven’t been able to use their credits in the past.
