Outside of restaurants, most of us try to avoid leaving money on the table, but not taking full advantage of Research and Experimentation Tax Credits (R&D tax credits) can leave money on the table at tax time—even when all appropriate deductions for R&D are already claimed. Fully leveraging your intellectual property (IP) can help you maximize the amount of your R&D tax credit.
The R&D tax credit is a tax incentive provided by the U.S. Federal Government since 1981 to encourage businesses to invest in new or improved qualified research and experimentation activities. Some states also offer state-level R&D tax credits. In many circumstances, R&D tax credits may be claimed in addition to R&D tax deductions.
Over the past few years, the applicability of R&D tax credits has expanded significantly. In December 2015, the PATH Act made the R&D tax credit permanent, and allowed for the application of R&D tax credits against alternative minimum tax liability or against FICA payroll taxes in some instances. In addition, the IRS subsequently issued favorable regulations regarding qualifying software. Because R&D tax credits are potentially worth approximately three times as much as corresponding deductions for R&D, companies that are able to leverage these favorable developments regarding R&D tax credits can achieve significant tax savings.
What does this have to do with Intellectual Property?
Cooperation between IP and tax professionals can help overcome two primary reasons companies often struggle to capture the full value of R&D tax credits: (1) difficulty identifying creditable R&D expenditures outside of ordinary channels, and (2) uncertainty regarding applicability of the R&D tax credit.
1. IP counsel (both in-house and outside IP counsel) can help identify non-traditional “R&D” activities that may hold potential for R&D tax credits that might otherwise be missed. Most companies capture a fair amount of qualifying tax credits associated with their main-line R&D, but other sources may be overlooked, particularly in the development of software tools used for R&D activities and for other company processes. In-house IP counsel are well-positioned to identify potential R&D tax credit expenditures when assessing projects and disclosures for possible IP protection. This is particularly true for projects that may not be able to be (or are chosen to not be) protected by IP, due to a time bar, subject matter, or other reasons. Often, invention disclosures (whether pursued or not) are a rich source of qualifying expenditures for R&D tax credits.
2. IP protections can significantly reduce the uncertainty around the extent of R&D tax credits that can be claimed. The patent safe harbor of 26 C.F.R. §41-4(a)(3)(iii) states that issuance of a utility patent “is conclusive evidence that a taxpayer has discovered information that is technological in nature that is intended to eliminate uncertainty concerning the development or improvement of a business component.” Thus, the issuance of a patent removes certain challenges to the validity of related R&D tax credits. Even without issuance, pending patent applications can be persuasive during review of the validity of related R&D tax credits. Moreover, information collected for purposes of preparing and prosecuting a patent application is frequently useful in establishing a record to support R&D tax credits. Consequently, some of the IP costs that are incurred by a company may be able to be recovered by corresponding R&D tax credits.
While IP counsel need not be experts in tax law (just as we are not tax experts, and the foregoing is not tax advice), it is nonetheless useful to recognize the overlap between IP professionals and tax professionals in identifying and claiming R&D tax credits. In-house IP counsel can often spot potential R&D tax credits that tax professionals cannot, while review of R&D for tax purposes can often uncover potential IP to be protected. Outside IP counsel can assist by identifying and protecting IP related to R&D. When both IP and tax professionals are involved in identifying potential credits, significant value can be generated.