Tax Credits and Incentives for Innovation Available to Phoenix Businesses

There is a generous federal research and development (R&D) tax credit available to all businesses, but not every activity, even those that may seem research and development adjacent, makes a business eligible for the tax credit.

Arizona also has an exclusive R&D tax credit that operates under the same eligibility rules as the federal tax credit.

There are both refundable and non-refundable versions of the AZ R&D tax credit, with eligibility depending on the number of employees your business has (the refundable is only available to those with fewer than 150 employees and requires a Certificate of Qualification).

The Arizona R&D tax credit changes periodically. The current credit, available from 2011 through 2030, is 24 percent of the initial $2.5 million spent on qualifying R&D expenses, plus 15 percent of qualifying expenses over that amount.

Additionally, some businesses, depending on their industry and the type of R&D they’re pursuing, may be eligible for grants or special programs. Some of these may offer direct funding for specific types of R&D activities; usually those in high-priority industries or technology (like healthcare or environmental sciences). Some businesses may also qualify for economic development initiatives.

Businesses in biotech, pharmaceuticals, renewable energy or other sectors in which the government wants to incentivize R&D may be eligible for special tax incentives.

Making full use of state and federal R&D tax credits, grants and special programs can be complicated. Many businesses require the assistance of business tax preparers or a CPA to maximize the value of all the benefits they can potentially receive.

What Does and Doesn’t Constitute an Eligible R&D Activity?

There can be understandable confusion pertaining to what is considered an R&D activity for tax purposes. The IRS offers in-depth guidance through I.R.C. Section 41 and on their website, but in simple terms, the research and development needs to be geared toward making something new and involve some uncertainty about the outcome. Activities like quality assurance or data collection for study purposes won’t count, even if they may seem like research.

Some examples of activities that qualify as R&D include:

• Developing a new product: Designing, fabricating prototypes and testing new products that involve some degree of technological innovation or a significant improvement over past iterations of the product. These improvements can pertain to the product’s performance, functionality or even just reliability.
  
  
• Improving existing products: The products being developed don’t necessarily have to be new to be eligible for R&D tax credits. Enhancing an existing product via substantial improvements in performance, efficiency or environmental sustainability may qualify.

• Improving production processes: Developing or improving production processes to make them more cost-effective, efficient or environmentally friendly, including developing automation or advanced manufacturing techniques, may qualify.

• Developing software: In order for software development to be eligible for an R&D tax credit, the business must be able to show that the software is providing a significant functional improvement over existing software alternatives, particularly if it would overcome current technological hurdles.

• Prototyping and testing: Fabricating prototypes and the testing of prototypes of new technologies to validate new concepts or technologies often qualify, including trial and error experimentation used to find solutions for technological uncertainties.

• Developing environmental solutions: Pollution control, waste management or renewable energy research for environmental technologies are potentially eligible for R&D tax credits as well as other grants or special programs.

Some examples of what might not qualify as R&D include:

• Routine data collection: Market research and consumer surveys, even if their ultimate goal is to gain ideas for future R&D, do not typically meet the definition of technological advancement.

• Developing new business practices: Business models, management techniques or strategies don’t count as technological innovations, even if they are new. 

• Aesthetic changes: Simply changing the design, style or even taste (for food products) aren’t considered technological improvements.

• Developing software for internal use: The exception for R&D software development are those made entirely for internal use unless it can be shown that it contributes to a significant innovation or solving a technological problem.

• Maintenance and repairs: Maintenance or repairs typically won’t qualify for R&D credits.

Does Your Phoenix Business Need Help Claiming the R&D Tax Credit or Qualifying for Relevant Grants and Programs?

Identifying all the tax credits, grants or programs for which your business’s R&D efforts qualify and taking full advantage of them isn’t always easy. Specific types of documentation and substantiation are necessary, including things like lab results, project logs or documentation demonstrating the nature of the R&D as well as the challenges and risks associated with the process.

The business consultants and tax professionals at H&H Accounting Services can help your business substantiate your R&D qualifications and assist in maximizing these benefits. Call us at (480) 561-5805 for a free consultation.