With the passage of the 2018 U.S. Farm Bill, industrial hemp (defined as cannabis with less than 0.3% THC) was removed as a Schedule 1 drug from the Controlled Substances Act (CSA) and is no longer considered a federally-illegal controlled substance.
Not only is this a major win for American farmers, who are now legally allowed to grow industrial hemp here in the U.S., but this is a major win for businesses who operate in this space with respect to their tax liabilities.
Businesses involved in the trafficking of a controlled substance (i.e. cannabis and previously hemp and hemp-derived CBD products), are not allowed to take deductions or credits at the federal (and in most cases state) level, other than expenses related to the cost of goods sold (U.S. Code Section 280E).
Since the passage of the 2018 Farm Bill, hemp and hemp-derived product-oriented businesses are now eligible to take advantage of federal and state (if applicable) Research and Development (R&D) Tax Credits, in addition to other federal and state tax credits and deductions.
This is a huge boon for all hemp businesses that were previously paying astronomical income taxes because they could not deduct selling, general, and administrative (SG&A) expenses that they incurred during the normal business lifecycle.
Reasons to Celebrate the 2018 U.S. Farm Bill
We are witnessing the hemp and CBD industries emerge as serious players in the global market. Like any emerging industry, research and development is likely to be a new company’s largest expenditure. Thankfully, hemp-derived businesses will now be able to recoup expenses related to the development of new hemp/CBD products, processes, software, technology, inventions, patents, or new formulas through the R&D tax credit.
What are Research and Development (R&D) Tax Credits?
Originally enacted in 1981 under the Economic Recovery Tax Act (ERTA), the R&D Tax Credit has expired eight times, been extended 15 times, and was made a permanent federal tax incentive in 2015 under the Protecting Americans from Tax Hikes Act (PATH Act).
To qualify for R&D tax credits, a business activity must satisfy all four parts of the “Four-Part Test”:
- Permitted Purpose: Intended purpose of the activity or project must be to create or improve functionality, performance, reliability, or quality of a business component. The business component is defined as any: product, process, software/technology, invention, patent, or formula.
- Elimination of Uncertainty: The activities and projects in question must attempt to eliminate uncertainty related to: design, development methods, or components capabilities.
- Process of Experimentation: The activities must include the process of experimentation of the unknown that would include: testing, evaluating alternatives, or systematic trial and errors.
- Technological in Nature: The activities and process of experimentation must rely on hard sciences, such as: computer science, engineering, chemistry, biology, or physics.
OK, so you think your business activities satisfy all the criteria in the Four-Part Test. You are now probably wondering: “How are R&D tax credits generated?”
What Expenses Qualify for the R&D Tax Credit?
After identifying which projects or business components qualify, the next step is determining which expenses you can apply towards the credit.
- Wages – Taxable wages (W2 Box-1) paid to employees directly engaged in qualified activities (discussed below), or those employees directly supervising or supporting those performing the research.
- Supplies – All supplies and raw materials used or consumed in the R&D process, including those expenses for prototypes or for testing materials can be claimed.
- Contract Research – Payments made to a third party vendor (contractor, subcontractor, or 1099) to perform qualified research or testing on behalf of your business.
Once the qualified research expenses (QREs) have been identified, roughly 10% of those QREs generate a federal R&D tax credit, which dollar-for-dollar reduces income, or payroll tax, liabilities. Whereas each state has its own version of the R&D tax credit, some states follow the federal methods and can generate an additional 10% state credit. However, state R&D tax credits can vary from 3% – 12% of QREs, so it’s important to include available state credits to maximize your company’s benefits.
What Activities Qualify for the R&D Tax Credit?
Some examples of qualified research activities (QRAs) that hemp farmers, manufacturers, processors, distributors, entrepreneurs, and innovators are performing include any of the following:
- Developing new hemp/CBD strains or cross-breeding genetics
- Experimenting with optimal LED lighting, nutrients, soil, etc. to improve efficiency of plant growth, harvest yields, and quality of plant life
- Testing alternative grow methods (indoor vs. outdoor), including growing unique genetics in different geographical locations
- Streamlining and automating the growing process using technology (process improvements)
- Developing and manufacturing new and improved hemp/hemp-derived CBD products (edibles, oil concentrates, drinks, vape pens, lotions, topicals, tinctures, pet products, etc.)
- Testing alternative drying and curing methods to increase production levels
- Experimenting with formulas for optimal products and processes
- Designing new packaging and evaluating alternative shelf-life methodologies
- Developing proprietary or patented products, processes, or inventions
- Developing technologies in the hemp supply chain such as seed-to-sale technologies, inventory management software, unique strain identifier technologies, grow-system automation technologies, etc.
- Developing new extraction equipment, grow systems, LED lights, filling systems, smoking devices, or grow equipment
- Evaluating new or improved business processes for maximum efficiencies
As you can see, there are many activities that qualify for the R&D tax credit in the hemp and CBD industries for the 2019 tax year and beyond.
If you, or a business you know, is involved with a hemp or hemp-derived CBD/product business, visit our FAQs page to learn more about the R&D tax credit. Or better yet, contact a member of the HempTax Credit team today to see if your business activities qualify and how much you could be entitled to.
At HempTax, we specialize in working with hemp and CBD companies to maximize R&D credits and make sure your company isn’t leaving any money on the table.
Did you enjoy this article?