Taxlink by Andy Biebl

Tax Credit for R&D

Andy Biebl
By  Andy Biebl , DTN Tax Columnist
A hog producer conducting a series of tests involving new feed supplements to improve pig weight gain and health is just one example of a farming activity that might qualify for a research and development tax credit under Section 41 of the tax code. (DTN file photo)

The tax law is loaded with specialized tax credits, designed to reward what Congress views as desirable activities. Rehab a pre-1936 building or undertake countless other noble economic actions and a tax credit will reduce your federal income tax.

But we find few tax credits that are useful for traditional grain and livestock producers. But here is one that might actually be attainable for the right producer under the right circumstances.

RESEARCH CREDIT BASICS

Since the 1980s, Section 41 of the tax code has provided a credit to a business that increases its research and development (R&D) expenditures. The tax credit applies to businesses that conduct scientific testing, including biological research, and do so with a process of experimentation to develop new or improved performance or reliability. A law change in 2016 made the research credit more taxpayer-friendly. In the case of a small business under $50 million in average annual gross receipts, this credit now offsets both regular tax and Alternative Minimum Tax.

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AN EXAMPLE

Assume a hog producer conducts a series of tests involving new feed supplements to improve pig weight gain and health. A control group of hogs is kept on the normal feed diet, while two other identical groups each receive different feed and vitamin supplements. All three groups are regularly measured for weight gain and health status, with documentation at each stage of the process. The research credit applies to the labor and the supplies that are expended in this process of innovation. The business maintains documentation of the daily labor hours and new nutrient costs and uses those expenses to compute the tax credit.

Assuming election of the simplified version of this credit, in the first three years of conducting qualified research, the tax credit is 6% of eligible expenses. Thereafter, the business claims a credit of 14% of the excess of current R&D expenses over 50% of the average R&D of the prior three years. In measuring labor expense, salaries to owners involved in the R&D can be considered, as well as the self-employment earnings of proprietors and partners. However, the income tax deduction for the labor and supply expenses must be reduced by the amount of credit that's claimed (unless a reduced credit is elected that brings the same result). Effectively, the credit is diluted by the amount of the taxpayer's normal income tax rate.

Obviously, it is larger ag producers who might be inclined to conduct this type of testing. Those that do should recognize that the additional documentation of hours and costs can produce a beneficial tax result. Seed producers and livestock producers are categories in ag where this credit may apply.

A WORD OF CAUTION

The IRS does scrutinize research credits, and there can be challenges over whether sufficient innovation occurred and the quality of the taxpayer's documentation. Use specialists who are experts in the research credit computations and documentation.

Tax Columnist Andy Biebl is a CPA and tax partner with the accounting firm of CliftonLarsonAllen, in New Ulm and Minneapolis, Minn.

Read Andy's "Ask the Taxman" column at about.dtnpf.com/tax.

You may email Andy at askandy@dtn.com

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