TECHdotMN: News about Minnesota Startups

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.