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March 2008
Research and Development
Costs
By Barbara A. Krout
Research and Development ("R & D") expenditures are
reasonable costs that are incurred in trade or business and are intended
to provide information to help eliminate uncertainty about the development
or improvement of your product. Determination of whether expenditures
qualify as R & D depends on the nature of the activity that the
expenditure relates.
Neither the nature of the product being developed or improved, nor the
technological advancement level matters when making this decision. R &
D expenditures generally include all expenditures that are incident to the
development or improvement of a product (which includes a formula,
invention, patent, pilot model, process, technique or similar product).
They also include the expenditures for costs such as attorney's fees
incurred while making and finalizing a patent application. They do not
include expenditures such as quality control testing, advertising or
promotions, consumer surveys, efficiency surveys, management studies,
research in connection with literary, historical, or similar projects or
for the acquisition of someone else's patent, model, production, or
process.
There are three options to deducting R & D expenditures against
income. The first option would be to take the full deduction in the year
you incurred the R & D expenditures. You can select this option only
in the year you incur such expenditures and if you fail to choose this
option in the first taxable year, you cannot do so in the subsequent
taxable years unless you obtain the consent of the Internal Revenue
Service Commissioner. The second option is to write the R & D
expenditures off over an optional 10-year period beginning with the tax
year the expenditures were incurred. The third option is to amortize the R
& D expenditures by charging them to a capital account; you can then
amortize the R & D expenditures equally over 60 months or more. This
is only allowable if you paid or incurred the R & D expenditures in
your trade or business and you are not deducting the expenditures
currently.
There also is a credit allowed for additional research activities. This
research credit is generally allowed for expenditures paid or incurred for
qualified research. To be classified as a qualified research expense it
must meet all four of the following criteria. The related expenses need to
(1) qualify under Section 174, that is, the expense must be incurred in
connection with the taxpayer's trade or business and it must represent a
research and development cost in the experimental or laboratory sense, (2)
the expenses are undertaken for the purpose of discovering information
which is technological in nature, (3) the application of such expenses is
intended to be useful in the development of a new or improved business
component of the taxpayer, and (4) substantially all of the activities
from the expenses constitute elements of a process of experimentation for
a qualified purpose. The calculation of such credit can be very tedious
and time consuming and should be done by a qualified tax professional.
If you would like additional information regarding R & D costs, please
call our office.
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Certified Public Accountants
1035 N. Main Street, Findlay, OH
45840 - Phone: 419-422-8111 - Fax: 419-422-5969
2453 West Market Street, Tiffin, OH 44883 - Phone:
419-448-8555 - Fax: 419-448-5885
Questions or comments? Please email ksc@knuevenschroeder.com
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