What is the R&D Tax Credit, and How do I Claim It?
Organizations can save on taxes by using the Research and Development tax credit. However, many business owners need to be aware of the R&D credit or believe it applies to their situation.
To claim it, having test tubes or lab coats is unnecessary. Yet, this is everything you need about the research-and-development tax credit.
What's the R&D tax credit for?
The R&D credit is a tax incentive for U.S. businesses and is applied as a tax credit. It encourages companies to spend more on research and development in the U.S. This credit reduces tax owed or increases a tax refund. There are two methods to determine if a company is eligible for R&D credit.
Traditional
The traditional method allows a 20% credit to be applied to qualified research expenses exceeding a base amount.
It is challenging to calculate the base amount as it's a sum of a fixed percentage and the average annual gross income for the previous four tax years.
The second method is easier for companies that have yet to claim an R&D credit or need more data to calculate their qualified research expenses in the past.
Alternative Simplified Credit Method
There are four steps to calculate research credit using Alternative Simplified Credit (ASC).
The average QRE (qualified research expense) of the company for the last three years is shown below.
Multiply this average by 50%.
Add the result of Step 2 to the current year QREs for the company.
Multiply the Step 3 result by 14% to calculate the credit.
Let's say Bob's Plumbing has had these QREs over the last three years.
Sample qualified research expenses
2019 $50,000
2020 $45,000
2021 $60,000
The average QRE of Bob's Plumbing for the last three years would have been $51,667. This is equal to 50%.
They would calculate the available R&D credit if Bob's Plumbing had $70,000 in research expenses in 2022.
$70,000 - $24,167 = $45,833 + 14% = $6.417
Tax savings of 6% are available if the company has not had any research expenses in the past three years.
Many states also have their R&D tax credit programs. Each program has its own rules and limitations, so it is a good idea for you to speak to a tax professional in your area to determine if you are eligible to receive both federal and state credit.
How can Basis 365 help
It's important not to leave any tax deduction or credit on the table. You'll be able to access every IRS discount with consistent and clean financials. Basis 365 can help gather the necessary information needed for the calculations and support. We partner with great R&D experts that we can recommend to you.
Who is eligible to claim the R&D tax credit
Any business that spends money while developing new products or processes on U.S. soil can apply for R&D credit.
A simple four-part test can determine the federal tax credit.
Eliminate uncertainty. To eliminate uncertainty regarding developing or improving a product/process, you must have conducted the research. Also, aesthetic changes don't count.
Method of experimentation. Activities must include some investigation to solve technical uncertainty. This could be modeling, simulation, systematic test, error, or any other method.
Technological in Nature. Research must be based on hard sciences such as engineering, physics, and chemistry.
Qualified purpose. The activity must have a purpose. It should result in a new or improved product, process, or outcome that is more reliable, efficient, performant, or of higher quality.
The IRS Instructions For Form 6765, which is used to claim R&D credit, lists the following activities as exempt:
After commercial production began, research was conducted.
You can adapt an existing product or process to meet a specific customer's needs.
Duplication of an already existing product or process.
Surveys and studies.
Research on particular computer software for internal use.
Research done outside the United States, Puerto Rico, or any U.S. possession.
Research in the arts, humanities, and social sciences.
Research funded by another person, or governmental entity.
How can I calculate the R&D credit for my project?
To calculate the R&D credit, you must document your company's "qualified researcher expenses."
People who directly support, supervise, or work on the development process are paid wages.
Materials used or consumed during development.
For qualified research activities performed on behalf of the company, contract research expenses were paid to a third party.
Research activities: cost of cloud service providers and leasing computers.
Research can result in something other than a successful product or process for expenses to be counted. However, you can still claim the credit even if the research or project fails.
Special rules for startups or new businesses
Although the federal R&D credit is not refundable, if your credit amount is more significant than your tax bill, your credit can be carried forward for up 20 years. As a result, new businesses with high research costs but little to no income tax liability can take steps to reduce their tax burden.
Protecting Americans From Tax Hike (PATH Act) of 2015 allows small and new businesses to apply for R&D credits against their payroll tax (FICA). This is for up to five years. As a result, companies can receive a tax benefit for their research activities, regardless of whether they are profitable.
The company must possess the to be eligible for the payroll tax offset
Maximum five years of gross receipts
In the credit year, less than $5 million in gross receipts
An eligible business can apply up to $250,000 of its R&D credit each year to its payroll tax liability. This option must be selected on the original tax return. You must apply the R&D credit for payroll taxes in a previous year to be able to correct it by filing an amended return.
Eligible small businesses can also use the PATH Act to offset AMT by utilizing the research credit. However, the company must meet the following requirements to be eligible:
Publicly traded
A minimum of $50 million in gross receipts during the three previous tax years
Bottom line
Not only can large corporations benefit from the R&D credit tax credit, but so do other companies. They often have an accountant and lawyer to help them navigate the rules.
These questions will help you determine if your R&D activities are eligible for credit.
Are you a maker? Credit may be available to software, manufacturing, or engineering companies.
Do you make the same product differently every year? It doesn't matter if the new product or process is unique to the industry, but it does need to be unique for the company. Businesses make their products different year after year. Credit may be available to companies researching to improve their products and processes.
If the answers to both questions are "yes," you may want to speak to your controller for more information on the R&D credit. While we are not a tax firm, we partner with multiple companies to help provide you with a clear path forward.
