Just like many other businesses, oil and gas companies frequently overlook taking the Research & Development (R&D) tax credit. Across all industries, less than 33% of the companies that qualify for the federal R&D tax credit take it and, therefore, miss the opportunity to save money on their taxes. Oil and gas companies that continually invest in R&D activities are likely to qualify for the credit.
The R&D tax credit allows companies to deduct expenses related to developing new processes, efficiencies, or initiatives that eliminate uncertainty within the business. To be eligible, R&D activities must be done in the U.S. and meet the criteria of the following four-part test:
- Technical in nature – The R&D must be scientific and based on the principals of engineering, physics, biology, or computer science.
- Permitted purpose – R&D projects must be for a new or improved aspect of the business such as processes, functions, products, and quality assurance, that provide for a substantial reduction in costs.
- Elimination of Uncertainty – You must demonstrate that you’ve attempted to eliminate uncertainty about the development or improvement of a product or process.
- Process of experimentation – Qualified research that involves trial and error and an evaluation of alternatives to achieve a desired result which was previously uncertain. Documentation on the hypothesis and testing procedures are required by the IRS.
Oil and gas companies may qualify for the R&D tax credit for activities conducted in their day-to-day operations. These include, but are not limited to:
- Conducting environmental testing and remediation
- Alternatives and improvements to drilling
- More efficient ways to refine oil or gas
- Offshore structure design pertaining to helidecks, process modules, etc.
- Plug and abandonment solutions
- Turnaround and shutdown services
- Containment systems
- Fracking techniques
- Fuel combustion testing
- Development of transport alternatives
- Certain improvements to plant design (e.g., pressurization and safety)
- Wastewater treatment solutions
R&D tax credits are taken on a dollar-for-dollar basis on either the entire qualified project or the portion of the project that meets the criteria of the four-part test. The federal R&D tax credit can generally yield a 5-7% return on qualifying projects. Some states also offer a R&D tax credit for activities done within their border.
Make sure that you document all R&D activities, including the processes used, hours invested, and financial resources. IRS guidance suggests using a project, cost center, or hybrid approach to compute the tax credit. The portion of an employee’s W-2 wages associated with researching, performing, supervising, supporting, or working on a qualified project may be included in the computation, as well as the cost of certain materials used or consumed in the R&D process. This credit may be carried back to the previous year, and carried forward for 20 years.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 made the R&D tax credit permanent. Congress included two changes so mid-size companies, small businesses, and start-up ventures can take advantage of the R&D tax credit. As of January 2016, eligible businesses ($50 million or less in gross receipts) may claim the credit against the Alternative Minimum Tax (AMT). Small businesses can offset the credit against their payroll tax liability (capped at $250,000 for up to five years). To qualify a small business must have less than $5 million in gross receipts in the taxable year and zero gross receipts for any tax year before the 5-tax-year period ending with the taxable year.
Taking advantage of the R&D tax credit may substantially reduce your tax obligation. The money saved will give you extra funds to invest in your business. Contact a member of the LaPorte Energy Industry Group to see if you qualify for the R&D tax credit. We are always happy to help.