Minnesota’s R&D Tax Credit applies equally to software companies

In line with MOJO Minnesota’s goal of supporting early-stage technology companies, the group held its second official public gathering yesterday to focus specifically on Minnesota’s R&D tax credit —  a “sleeper feature” included within the passage of H.F. No. 2695 earlier this year.

More educational than agitational in nature, the collective brought in guest Scott Schmidt, Principal at Black Line Group (and Founding Partner of ActiFi) to share his experiences around helping a variety of small to medium sized cross-sector companies benefit from the publicly-subsidized tax incentive.

Overshadowed by the Angel Investor tax credit component of the jobs bill,  Minnesota’s R&D tax credit was previously a non-refundable credit for incremental qualified R&D expenditures set at 5% for the first $2 million spent and 2.5% for all incremental qualified expenditures over $2 million.  The updated R&D tax credit has expanded significantly in scope:

  • 10% refundable credit for first $2 million spent on incremental qualified R&D expenditures
  • 2.5% for all incremental qualified expenditures over $2 million
  • Qualifying companies to include S corporations, partnerships, and individuals.
  • Refundable: if the amount of tax credits qualified for exceed a company’s Minnesota tax liability, the balance will be paid as a tax refund

“Qualified R & D spending takes place in many areas within a business; it’s not exclusively reserved for the R & D or Engineering department,” according to Schmidt.  Internal labor, including direct research, supervision/support of research, supply costs, and external labor can be considered R&D spending.   These expenditures should also occur within the state of MN.

Generally, a qualified R&D activity will:

  • Be conducted for a permitted purpose
  • Intended to resolve technical uncertainties
  • Involve a process of experimentation
  • Use a permitted science

“Software product development, methodologies, algorithms and improvement – v1, v2, etc. – all those incremental enhancements are R&D,” Schmidt articulated, adding “Internal use software has a higher threshold of qualification but the external software development only has to meet the 4 Part Test.”

The R&D tax credit 4 part test:

  • Permitted purpose test: what is the goal of this project? Evolutionary development?
  • Technological uncertainty test: what is not known at the outset of the project?
  • Process of experimentation test: what was done to eliminate the uncertainties?
  • Technological in nature test: what science is being relied upon as the activity is performed?

Minnesota aside, Schmidt also discussed the Fed’s version of the R&D tax credit, which expired on Dec 31, 2009.  Although likely to be renewed (like the 13 times before it) qualifying organizations will be eligible to retroactively double-up on their credit by claiming both the State & Federal credits.

While enlightening, the presentation left some with more questions than answers surrounding the technical nuances and semantics of the Minnesota legislation.  “Good question…I don’t know… Since this legislation just became enacted, I’m not an expert in every facet (yet),” Schmidt candidly deflected when faced with legitimate yet highly circumstantial queries from CPA’s and savvy executives amongst the audience of around 30.

To his defense, the rules lack clear guidance in many aspects and are dependent upon a multitude of factors. Since there is no one size fits all response to many of the questions raised, and the federal form 6765 doesn’t provide the answers, many companies refer to the R&D tax credit experts to make those interpretations. Unlike the Angel Tax Credit, no application or pre-qualification is necessary as credits are claimed on the companies tax form.

“This is a mushy part of the tax code and it’s underutilized for that very reason — it’s gray, specialized, unclear in many instances, and can even be intimidating,” he reiterates.  Now considered a “Tier-1 tax issue” for federal (state guidelines follow federal), the strategy has been subject to a higher level of scrutiny in recent years.  However, Schmidt adds, “This doesn’t mean you shouldn’t take advantage of the incentive, it means you should make sure you take a solid approach to it.”

Like anything new, many of the answers come through learning by doing.  There’s no reason not to explore the ways by which this readily available technique could save your software company some hard earned money from 2010 and beyond.

Comments

  • Dave44000

    “Internal use software has a higher threshold of qualification…,” so this law is just a way to transfer public monies to the private sector for nothing, absolutely nothing at all. Oh, well.

    Very bad law.

  • http://pulse.yahoo.com/_I5TRNMI23R3WHC4BU6MAHBCRVA Jeffrey

    The MN state R&D tax credit is a great program, especially for many of our small to mid-size clients in the state. Recent changes (enacted just last week) to the Federal R&D tax credit program should also be considered by companies in MN. Here is a recap of the new Federal changes, and companies can find out more, about both Federal and state credits, by contacting me at Tax Point Advisors (800-260-4138, http://www.taxpointadvisors.com, email jeffreyfeingold@taxpointadvisors.com):

    PRLog (Press Release) – Sep 28, 2010 –

    (Newswire Today) — South Walpole, MA, United States, 09/28/2010 – Businesses under $50m will be able to use general business tax credits – including the R&D tax credit – to offset Alternative Minimum Tax in 2010.

    New Legislation Allows CPA’s to Offset AMT with General Business Credits!

    President Obama’s signing of H.R. 5297 this week marks a significant modification in the law for both corporations and business owners with respect to their utilization of General Business Credits. Prior to this new law, the maximum amount of General Business Credits that a company or individual business owner could utilize in a given year could be no greater than the amount that their regular tax exceeded their AMT. Likewise, they could not utilize any General Business Credits if their AMT exceeded their regular tax. With H.R. 5297 in place, these limitations no longer exist. General Business Credits can be utilized up to the full amount of the corporation or individual’s tax liability. In addition, the new law allows for a carry-back of 2010 General Business Credits to any of the previous five years; whereas, the previous law only allowed for a carry-back of one year.

    There are two very important points to keep in mind with this change, however. The first is that only General Business Credits resulting from activities in the current 2010 tax year can be utilized, so you can not use credits that have been carried forward from previous years. The second is that you can not offset AMT if you are carrying back credit from the 2010 tax year to one of the previous five years.

    “This new bill is a significant benefit for many of our small to mid-sized clients across the country,” noted Jeffrey Feingold, Managing Partner of Tax Point Adviors, a national tax consultancy which specializes in government-sponsored credits and incentives. “Previously,” Feingold added, “many of our clients who qualify for R&D credits were unable to utilize the credits due AMT. This bill will begin to address that problem for the first time. Still, Congress should go one step further and allow the credit to offset AMT for prior years as well as for 2010.”

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