Formulating a Better Bottom Line With The R&D Tax Credit 13th Annual Worthington Bio Conference Scott Schmidt April 7th, 2017 The R&D Tax Credit | April 7, 2017

Agenda What is the Credit What’s New with the Rules Potential for Bio and Life Science Companies Qualifying Activities & Expenditures The Four Part Test Documentation Using a Pro The R&D Tax Credit | April 7, 2017

What is the Credit? Federal and State Credits Available The R&D Tax Credit | April 7, 2017

What is the Federal R&D Tax Credit? A tax incentive provided by the U.S. government to encourage businesses to invest in activities within the U.S. that will provide for product and process improvements and/or the introduction of new products or processes Applicable to C-Corps, S-Corps, LLCs, Partnerships, Sole Proprietorships and Joint Ventures The R&D Tax Credit | April 7, 2017

Minnesota State R&D Tax Credit First state in the country to have an R&D Tax Credit The amount of the credit is equal to 10 percent of qualifying expenses up to $2 million, and 2.5 percent for expenses above that level. R&D expenses that qualify for the federal R&D credit and are for research done in Minnesota over a base amount Follows the federal R&D credit, but based on Minnesota gross receipts The R&D Tax Credit | April 7, 2017

Minnesota State R&D Tax Credit The current proposal: Makes the credit refundable up to $100K on the first tier Increases the credit rate from 2.5 percent to 4 percent on the second tier. Creates a simplified calculation The R&D Tax Credit | April 7, 2017

Rule Changes New Legislation Impacts Eligibility The R&D Tax Credit | April 7, 2017

New Legislation Protecting Americans from Tax Hikes Act of 2015 (PATH) R&D Tax Credit is now permanent Eligible Small Businesses may claim the credit against the Alternative Minimum Tax (AMT) Average sales of less than $50 million over the prior three tax years For tax years beginning after December 31, 2015 Can amend for 2016 if did not claim timely! Certain Start-Up Companies may apply credits against the employer’s FICA Payroll Tax liabilities Current year sales of less than $5 million   The credit may not exceed $250,000 per year Can’t claim for more than 5 years Cannot have gross receipts for more than 5 years (Tax Year 2016: No gross receipts in 2011 or earlier years) The R&D Tax Credit | April 7, 2017

Tax Credit Potential What can Biotech & Life Science Companies Expect? The R&D Tax Credit | April 7, 2017

Tax Deduction & Tax Credit < Deduction Income on which you do not pay tax. Credit Dollar for dollar reduction in the amount of taxes paid. You May Qualify for Both The R&D Tax Credit | April 7, 2017

An opportunity for the asking Roughly $9+ billion in R&D Tax Credits are claimed by businesses each year The R&D Tax Credit | April 7, 2017

What Qualifies? Qualifying Activities and Expenditures The R&D Tax Credit | April 7, 2017

Qualifying Expenditures R&D spending includes: Internal labor- (Box 1/W2 - salaries, wages, bonus) Directly performing research Directly supervising of research Directly supporting of research Supply costs (lab supplies, prototype costs, etc.) External labor (contractor payments) if: Payment is based upon T&M Rights are retained The R&D Tax Credit | April 7, 2017

Examples of Qualifying Activities Discovery and development of new methods for drug delivery Development of biosimilars relating to advanced biologics, assays and testing protocols Development of new therapeutic drugs, compounds, or molecules used in synthesis experiments Designing and developing medical device equipment used for treating various diseases Manufacturing experimental qualification lots and clinical trial lots Multi-application approach to synthetic microbe Developing biofuels from plant waste Development of bioremediation techniques Developing fuel and feed from plant biomass The R&D Tax Credit | April 7, 2017

Four Part Test How to Determine Eligibility The R&D Tax Credit | April 7, 2017

4 Part Test: Does Your Work Qualify? Any new OR improved product, formula, process or software development initiative may qualify for R&D tax credit qualification Activities must pass a simple four part test Non-intuitive examples?? In general, activities are eligible for the R&D tax credit if they are: Being conducted for a permitted purpose (i.e. improved quality, reliability, functionality or cost reduction), Intended to resolve technological uncertainties through a process of experimentation, Using a permitted science (i.e. any of the engineering sciences, chemistry, biology, or computer science) The R&D Tax Credit | April 7, 2017

4 Part Test: Does Your Work Qualify? To qualify as an R&D activity, the activity must: Be intended for the development or improvement of business components Eliminate uncertainty Use a process of experimentation Be technological in nature Non-intuitive examples?? In general, activities are eligible for the R&D tax credit if they are: Being conducted for a permitted purpose (i.e. improved quality, reliability, functionality or cost reduction), Intended to resolve technological uncertainties through a process of experimentation, Using a permitted science (i.e. any of the engineering sciences, chemistry, biology, or computer science) The R&D Tax Credit | April 7, 2017

Test #1: Does Your Work Qualify? The development or improvement of business components A business component is any: Product Process Technique Formula Invention Software Application The R&D Tax Credit | April 7, 2017

Test #2: Does Your Work Qualify? Must have uncertainty: Information sought must be intended to eliminate uncertainty Uncertainty exists if, at the outset, the available information does not establish the taxpayer’s: Capability of developing or improving the business component, Method of developing or improving the business component, OR Appropriate design of the business component The R&D Tax Credit | April 7, 2017

Test #3: Does Your Work Qualify? Process of experimentation: Experimentation is the evaluation of multiple alternatives, including developing and testing hypotheses, modeling, simulation, and systematic trial and error Research must substantially relate to new or improved function, performance, reliability, or quality Experimentation goes beyond the “lab” – It includes both conference room and shop floor experimentation time Failures Count!!! The R&D Tax Credit | April 7, 2017

Test #4: Does Your Work Qualify? Technological Criteria: Process of Experimentation must fundamentally rely on principles of science including: Physical Biological Engineering Chemical Computer sciences The R&D Tax Credit | April 7, 2017

Case Study Client: A leader in biologics manufacturing and process development R&D: R&D activities included: testing & assay validation, validation studies, forensics research, drug development, stability study testing & management Sales: $7.5 Million Credit: $85,000+ Federal & MN State Credits The R&D Tax Credit | April 7, 2017

Documentation What and How to Document The R&D Tax Credit | April 7, 2017

Documentation What to Document: Track supply costs by project for expenses which are used during the development process Document the development process, not just the end result (i.e. failures) Establish nexus between QREs and QRAs Gather contemporaneous documentation that supports research efforts The R&D Tax Credit | April 7, 2017

Examples of Documentation Time tracking & Project Tracking Product or Project Specifications, Descriptions, or Proposals Test Reports and Laboratory Results Documentation of alternative supplies/materials/technology evaluated Patent Applications or Abstracts Contracts with Consultants and Customers And more! The R&D Tax Credit | April 7, 2017

We Can Help Benefits of Working with a Professional The R&D Tax Credit | April 7, 2017

Getting the Credit You Truly Deserve Accurate and Defendable R&D Tax Credit Study Approach A process that is led by someone experienced in this area of tax and up to date on current rules Implements a methodology that is consistent and addresses all requirements of the code Calculates the credit amount (Form 6765) Creates documentation to support the credits claimed Partners with your CPA firm to ensure an accurate claim and usability of the credits The R&D Tax Credit | April 7, 2017

Next Steps If not yet filed, evaluate the R&D Tax Credit opportunity for the current tax year Evaluate whether it makes sense to go back to prior years Can meaningful tax credits be used or carried forward? Can the claim be adequately documented? Raise awareness and put in place a process to make utilizing the R&D Tax Credit turn-key The R&D Tax Credit | April 7, 2017

Thank You Don’t hesitate to contact us after the presentation with any additional questions Scott Schmidt scott@monetek.com 612-559-3388 The R&D Tax Credit | April 7, 2017