Leveraging the R&D Tax Credit on an Existing Product

3 Minute Read
Posted by Randy Eickhoff on Jun 13, 2019 12:30:13 PM

Since its official launch back in 1981, the research and development tax credit has offered companies in a wide range of verticals access to several potentially lucrative tax savings opportunities. Unfortunately, like many federal programs, the rules, regulations, and legislation surrounding the R&D tax credit can seem a bit murky for entrepreneurs. One of the biggest misconceptions about this cash-infusing tax program? Many business owners assume the research and development tax credit only applies to brand new product development.

Recognize Some of the Innovation Tax Credit's Biggest Misconceptions

It's true that for business owners innovating a new product, the research and development tax credit can prove a vital cash resource that helps defray expenses associated with the cost of development, such as:

  • Employee wages
  • Costs of materials used to build the prototype
  • Third-party contractors involved in the development process

However, many business owners are completely unaware that they don't have to invent a new prototype to qualify for the R&D tax credit program. This broad initiative may also apply to products that have been pulled from an organization's existing inventory, as well as products that the business has purchased with the purpose of initiating a significant improvement to either:

  • Performance
  • Reliability
  • Quality

In short, while the company doesn't have to create something new, it does need to prove intent to create something better than what has existed previously.

Does Your Existing Product Qualify for the R&D Tax Credit?
Understanding three core qualification standards for the research and development tax credit can help you determine if your operations on an existing product are eligible for the incentive. The three principles include:

Existing Product Adaptation
Unfortunately, slight modifications aren't enough to qualify for the innovation tax credit. The IRS regulations specifically disallow expenses incurred when making only minor adjustments to performance, reliability, or quality of an item. According to legislation, minor adaptations or client customizations typically won't satisfy the technical requisite needed to demonstrate sufficient research and development.

Substantially-All Requirement
The substantially-all requirement allows companies to include associated qualifying expenses so long as at least 80% of the activities constitute a process of experimentation. The process of experimentation must include the evaluation of at least one alternative to alleviate technical uncertainties identified at the beginning of the project.

Shrink-Back Rule
In the event that the activities conducted for the improvements to an existing product make up less than 80% of the process of experimentation, the taxpayer cannot claim all expenses. However, the developing company may still claim the expenses incurred that demonstrate a substantial increase to required functionality, performance, quality, or reliability by shrinking back to include those expenses related to at least 80% of the process of experimentation.

Other Factors to Consider With Existing Products

When determining if a prototype or piece of equipment qualifies as a research and development supply expense, it's important to consider three essential factors:

  • Several prototype expenses may qualify as research and development costs, such as:
    • Development
    • Design
    • Fabrication
    • Testing
  • Expenses may not include assets that are depreciable in the hands of the taxpayer
  • Expenses must be incurred in the United States

Do you have questions about claiming the research and development tax credit on your current products? Acena Consulting, a leading innovator in the R&D tax vertical can help you navigate through the qualification process. Contact us today to schedule an appointment with our onsite tax experts.


Cheat Sheet Banner

Randy Eickhoff

Randy Eickhoff

Acena Consulting President Randy Eickhoff, licensed CPA, has partnered with more than 200 companies during more than 20 years of experience securing tax credits and other government incentives. His corporate partners range from multinational technology firms to smaller, privately held manufacturing, sports, and technology enterprises.