The oil and gas industry is no stranger to innovation, and substantial tax incentives are available to help support this activity. The R&D tax credit is available to companies developing new or improved products, processes, techniques, formulas, inventions, and software.
What is the R&D Tax Credit?
The R&D tax credit is a dollar-for-dollar tax savings that directly reduces a company’s tax liability. There’s no limitation on the amount of expenses and credit that can be claimed each year. If the R&D credit cannot be used immediately or completely, any unused credit can be carried forward for up to 20 years. In addition, previously filed tax returns can typically be amended for up to three years in order to claim the R&D credit retrospectively, providing an avenue to recoup previously-paid taxes.
The R&D tax credit is available both at the federal and state level, with approximately 40 states offering an R&D credit to offset state tax liability. State credits may also be carried forward for a length of time as determined by the state.
How much can a company save with R&D tax credits?
There’s no limit, but there are several factors that can impact savings. Some clients save a few thousand dollars and others save millions of dollars each year. Generally, the more a company spends to innovate, the more they can potentially save. Typically, companies can save up to 11% of annual R&D costs for federal purposes and much more when state credits are factored in.
Start-up companies and small businesses may be eligible to apply their federal R&D credit to offset the company’s portion of payroll taxes of up to $250K per year for five years, which is $1.25 million in potential savings.
What does the R&D credit apply to?
This often underutilized opportunity to reduce a company’s income tax burden offers significant tax savings to those that participate in qualifying activities by allowing them to include certain expenses directly connected to qualified research.
Qualified costs include:
- Taxable wages paid to employees for performing qualified R&D activities, which includes direct R&D, as well as first line managers and personnel who directly support the R&D projects
- Supplies and raw materials consumed during the R&D process such as developing prototype parts or components, pilot models, and destructive testing
- Contractor expenses paid for qualified R&D activities performed on behalf of the company
Examples of qualified personnel include:
- Petroleum engineers developing new field designs
- Mechanical, facility, industrial or industrial distribution engineers designing new facilities and tools
- Electrical engineers designing and implementing electrical systems
- Pipeline engineers designing and constructing new pipelines
- Welders and skilled fabricators supporting construction and design efforts
- CAD designers and modelers designing facilities and equipment
What are the activities within the oil and gas industry that qualify for the R&D credit?
To qualify for the credit, companies must prove they’re engaging in qualified R&D activities. Here are some examples of qualified activities companies might be engaging in at each stage of the petroleum production lifecycle.
- Development of new fields that are new to a specific operator
- Implementation of new drilling processes or completion designs
- Designing and constructing facilities and pipelines
- Cathodic protection
- Lease Automatic Custody Transfer (LACT) system design and installation
- Metering systems
- Lightning protection systems for holding areas and facilities
- Electrical and instrumentation implementation
- Processing facility design and construction
- Pilot plant design and construction
- Downhole tool and compressor design and manufacture
- Rig builders
- Auxiliary equipment design and construction
- Chemical manufacture
To apply for these credits, what’s the next step?
First, get an assessment of whether or not your activities qualify and how many credits are available. Second, once the scope of the potential credit is outlined and the required supporting documentation is submitted, schedule the necessary interviews and site visits, which are needed to help secure the credit. Significant tax planning should go into this process, because capital improvement projects can sometimes utilize different credits and deductions that impact tax liability when combined with carryforward limits. There’s a certain level of documentation required to successfully claim the credit, and there are penalties if done incorrectly.
To qualify for the credit, R&D activities must meet each of the following IRS criteria, known as the four-part-test, and be performed in the U.S. For R&D purposes, there’s no distinction between a project’s success or failure as long as the following criteria are met.
- Qualified Purpose: The goal of the research must be to create a new or improved product or process that results in increased performance, function, reliability, or quality.
- Technological in Nature: The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology, or computer science.
- Technical Uncertainty: The activity needs to be intended to eliminate uncertainty concerning the capability or method for developing or improving a product or process, or the appropriateness of the design.
- Process of Experimentation: This includes any activities undertaken to eliminate or resolve technical uncertainty, and requires evaluating alternative solutions or approaches through modeling, simulation, numerical analysis, systematic trial and error, or other methods.
We’re Here to Help
With recent increased IRS scrutiny around R&D credits, it’s crucial to understand what’s necessary to substantiate a credit claim. To learn more about R&D tax credits, see Five Misconceptions about R&D tax Credits—and if Your Company Qualifies, or request a complimentary credit benefit estimate to see how much your company could save.