There are two types of tax incentives: deductions and credits. As tax advisers, we always prefer credits. In most cases, they offset income tax liability dollar for dollar, whereas deductions only give you a benefit based on income-tax rate.
One of the better tax credits relates to increasing research and development (R&D) in your farm operation. Congress has expanded the availability of the credit, and many farmers now qualify to take it.
R&D Tax Credit Details
If your average revenues are under $50 million, this credit is allowed against the alternative minimum tax. Many farmers keep tax liability low, which might lead them to believe an R&D credit won’t help much. But if average revenues are less than $5 million, they will qualify for the R&D credit of up to $250,000 as an offset against federal payroll taxes.
Costs that qualify for the credit include:
- Payments to qualified organizations doing R&D.
- Wages for qualified services.
- Cost of necessary supplies.
- Rental or lease costs of computers.
The calculation of the R&D credit usually requires a qualified adviser. If you do have qualifying expenses, they might yield a tax credit of approximately 10% to 15% to reduce payroll or income-tax burden.
Four-Part Test
Your R&D activities must meet each of four IRS criteria:
- Research must have a qualified purpose. It must create a new or improved product or process to increase performance, function, reliability or quality.
- Research must involve experimentation. You must demonstrate through modeling, simulation or systematic trial and error that you’ve evaluated alternatives to obtain the desired result.
- Research must minimize uncertainty. You must attempt to eliminate uncertainty about development of a product or process.
- Research must rely on hard sciences such as engineering, chemistry or biology.
To offset the expense of performing an annual study, I would suggest you need to incur at least $100,000 of these types of costs. Most R&D advisory firms will provide a projection of possible R&D credit amounts based on your farm operation with little or no cost.
This might be especially true for farm operations with less than $5 million of average sales, since they can use this credit to offset payroll taxes.
Examples Of Qualifying Research and Development
Almost all progressive farm operations have several processes that qualify for the R&D tax credit. Here are some techniques that can be evaluated and implemented on crop, dairy and hog operations.
R&D Qualifiers for Crop Operations
- Increase yields via new seed varieties or other inputs.
- Protect crops from disease or pests.
- Enhance yields with new fertilizers or fertilization methods.
- Use new method of cropping (e.g. organic).
- Improve harvest cycle times.
- Improve field cultivation.
- Automate certain processes.
- Design specialized equipment for planting (e.g. no-till drills) or harvesting.
- Develop and implement new irrigation systems.
- Develop new software applications to use internally or to interact with customers and/or vendors.
R&D Qualifiers for Dairy Operations
- New dairy production systems.
- New ways to increase milk production.
- Increase the utilization of dairy pastures or feed.
- Eliminate or control dairy cattle disease.
- Create energy from dairy manure or byproducts.
R&D Qualifiers for Hog Operations
- Increase litter size.
- Increase little cycles per year.
- Create new ways to optimize the weight of hogs sent to market.
- New hog confinement systems.
- New ways of treating hog manure.
- Eliminate or control swine diseases.
Paul Neiffer is a tax principal with CliftonLarsonAllen and author of the blog, The Farm CPA. He recently purchased a 185-acre farm. Driving his cousin’s combine is his idea of a vacation.
