What is the Research and Development Tax Credit (R&D tax credit)?
The Research and Development Tax Credit (R&D) is a tax credit for businesses of all sizes who conduct R&D in the United States. The R&D tax credit can be extended to a wide range of business and industries that exceeds far beyond scientists and research labs.
The R&D tax credit was created to incentivize US-based research and development activity. Each year more and more companies take advantage of the R&D tax credit. Additionally, in 2015, the Protecting Americans from Tax Hikes (PATH) Act, made the R&D tax credits permanent, while also extending the benefit to startups.
What are the Potential Benefits of the R&D Tax Credit?
The R&D tax credits claimed by a qualifying company can potentially contribute to significant cost savings. These benefits include:
Qualifying for the R&D Tax Credit
Companies of all sizes and across many industries meet the federal government’s test for qualified innovation activities and can claim Research and Development (R&D) Tax Credits. However, many companies are not aware they qualify. There are thousands of companies that are leaving money on the table and not taking advantage of significant federal and state R&D tax credits.
Many people used to think R&D tax credits only applied to those that wear lab coats or create new best-in-class products. This is not the case – R&D credit is much more expansive and far-reaching than most people realize.
In addition, research and development tax credit guidelines for software development have relaxed. All of this opens the door for companies that have not taken advantage of or maximized their R&D tax credits in the past.
These research & development tax credit industries now include manufacturing, software, engineering, financial services, and many others.
If you’re improving or enhancing products and processes to remain relevant and profitable, you qualified for R&D tax credits.
The activities that qualify for theR&D tax credit are the same ones driving growth in your business.
How Do I Claim the R&D Tax Credit?
Ensuring that you understand the rules for qualification is an essential first step in claiming the R&D tax credit. This is normally done during a feasibility analysis, also referred to as Phase 1. R&D activities are explored and identified at a high level along with related qualified research expenses (QREs). This information is then used to estimate your federal and state R&D tax credits. Education is key and provides the ability to identify qualified activities and QREs so a more accurate benefit estimate can be determined.
The expenses that qualify for research activities within your company typically include employee compensation, materials, and contracted services. Various forms of documentation are sufficient to support your qualified expenses and may include payroll records, financial records showing supply or contract research expenses, and vendor invoices.
On average, companies are typically able to claim 7-10% of their qualified expenses as a federal R&D tax credit. For example, a single software developer, engineer, or lab technician who receives a W2 of $100,000 a year may generate a tax savings of up to $10,000.
Federal R&D Tax Credit Defined
Staying competitive requires companies to continually develop and improve products, processes, software, or perform other qualifying activities – making research and development the driving force behind the growth of many businesses. The federal R&D tax credit reduces past, current, and future years’ federal tax liabilities and is an actual dollar-for-dollar offset against taxes owed or paid. This creates an immediate source of cash that companies can reinvest into the business. Salaries and wages paid to employees or contractors for qualified activities as well as supplies associated with those activities qualify for R&D tax credits.
A company’s overall R&D spend can be significant. Many companies conduct R&D activities as part of their daily operations but might not realize it. They also tend to not realize that both Federal and State R&D Tax Credits are available to help offset the costs associated with research. Research activities are defined by a simple 4-Part Test to identify R&D projects. If you are performing activities that meet the four tests, the costs associated with those activities are what generate the credit. Many companies are often surprised at the broad scope of qualified research activities.
Qualified small businesses (less than 5 years of revenue history and less than $5M in current year revenue) that are not paying income taxes due to losses, can still realize cash savings through a reduction in payroll taxes.
R&D Tax Credit State Benefits Available
Most states offer R&D credits to offset state tax liabilities. We’ll guide you through variations in State and federal R&D tax credit rules, evaluating any states in which you qualify for and state-specific filing requirements.
The Source Advisors Approach to
R&D Tax Credits
With our consultative approach to the research and development tax credit, we invest time understanding each client’s history, current business direction, and future growth objectives. Each year we re-evaluate a company’s ability to accept the tax credit and provide on-going recommendations to improve the R&D tax credits process. We proudly support a recurring service to more than 92% of our clients.
No Cost Feasibility Analysis
One of our Source Advisors technical directors along with a business development representative will conduct the feasibility analysis to determine the estimated R&D tax credit benefits. Our professionals are the most experienced in the team and possess an average of 15+ years of R&D tax credit experience.
Understanding the Usability of the Credit Up-Front
We ensure that our clients and referral partners understand the usability of the credit upfront, eliminating situations where a study is completed and fees assessed but the credits does not result in immediate tax savings for the client.
Fixed Fees Include Audit Support
Our fixed fees are based on the scope of a project versus a percentage of the benefit. The fixed fee also includes audit support through appeals. Our approach to identifying and documenting credits provides a strong defense should the study come under audit, and our successful track record with the R&D tax credit irs gives our clients peace of mind.
Dedicated R&D Team
Our in-house dedicated team of professionals includes project managers, CPAs, attorneys, and other tax professionals, most of who were formerly with the Big 4 and average 8+ years of experience working with the R&D tax credit. This enhances both our responsiveness and study completion time. Our project managers remain assigned to clients on a year-over-year basis, which supports project continuity, helps us recognize new initiatives that may lead to more credits, and supports stronger audit defense.
Comprehensive Documentation Support
Our dedicated content compliance professionals have the industry knowledge and insight to identify qualified technologies and activities that support R&D tax claims. Proper documentation is essential to maintaining and protecting the tax credit and our strategy helps substantiate R&D progression, protects company interests, and ensures maximum value.
What is the federal Research and Development Credit?
The R&D credit is a business tax credit that can be used to reduce federal income tax and is available to companies developing new or improved products, processes, software, techniques, or formulations. Taxpayers qualify for the credit if they paid or incurred qualified research expenses while conducting qualified research activities.
How is the R&D Credit claimed?
The R&D tax credit is claimed on a timely filed tax return, including extensions. The R&D tax credit can also be claimed on amended tax returns. The rules for amended returns are generally the previous 3 tax years. The credit is reported on IRS Form 6765, Credit for Increasing Research Activities, for the year in which the qualified expenses were paid or incurred. For Sub-S Corporations, LLCs and other types of business entities, the credit is passed-thru to the shareholders on their individual Schedule K1.
Is there a limit to the amount of the federal research credit that can be claimed?
There is no limitation on the amount of R&D tax credits that can be claimed each year.
Is the R&D Credit a refundable credit?
The R&D tax credit is not refundable. Any Research & Development Credit that is not used to offset the taxpayer’s tax liability for the year in which the qualified research expenses were paid or incurred is carried back one with the remainder able to be carried forward for up to twenty years.
Can the research credit be claimed for a prior year?
Yes, a taxpayer can claim credits for prior tax years. Taxpayers typically have three years from the original filing date to amend. In some cases, more than 3 years will be available for amending.
How does the acquisition or disposition of a business entity affect the research credit computation?
Acquisitions or dispositions of trades or businesses should be identified when calculating the R&D tax credit for both the base period and the current year qualified expenditures. Consistency between these periods is required per IRC §41(c)(5). For example, if a company acquires another entity in the current year, that entity’s R&D expenses are included in the current year R&D tax credit calculation and the entity’s prior R&D expenses will also need to be reflected in the base period years.
Does the research credit provide a dollar-for-dollar cash savings of federal income tax?
Yes. A company computes its R&D tax credit and then that credit is directly applied against the company’s federal tax liability owed in the current tax year in which the credit is claimed. Unused credits then carryback one year and then forward for 20 years.
What is qualified research for the purpose of computing the R&D Credit?
The IRS has established a four-part test that taxpayers must apply to each of their business activities (components). The four tests are described in Internal Revenue Code (IRC) §41(d)(1) and all four must be met to qualify for the credit. In addition to the four tests, the company carrying out the work must bear the financial risk of development and have rights to the research being performed.
How is the R&D Credit computed?
There are two general methods for computing the Research Tax Credit, the Regular Credit (RC) Method and the Alternative Simplified Credit (ASC) Method. Both methodologies are included on IRS Form 6765, Credit for Increasing Research Activities. The taxpayer is permitted to elect either of the two methods when preparing a timely filed return, but since each method has distinct advantages and disadvantages, it is important to understand the two computation methodologies particularly because the elected method cannot be changed on an amended return.
What expenses quality for the R&D Credit?
Qualified research expenses (QREs) include taxable wages, supplies used in qualified activities, contract research costs and certain payments to cloud service providers.
How do I know if the credit will benefit my company?
The first step is to evaluate your ability to utilize the R&D tax credit. Since the credit is not refundable, you need to be paying take to benefit from the R&D tax credit process. Once it is determined there is sufficient tax available for your company to benefit from the credit, it is time to proceed to the next step which includes determining the qualifying research expenditures and
estimating your R&D tax credit.
Our company has been manufacturing the same products for several years. We do have some new products, but how is that Research & Development?
The definition of research for R&D tax credit purposes is quite broad. If you are conducting engineering activities that are new to you as a company and there is risk associated with the success of the outcome, this may qualify as R&D. Examples include developing new products or improving existing products; experimenting with new materials; building and testing prototypes and models; developing new or improved software applications; testing new concepts; and developing or improving manufacturing processes. Any company trying to improve what they do, be more competitive, reduce costs or increase market share will likely have qualifying activities.
How much company time and effort will this require?
Many of our clients have this concern at the outset of the project and are surprised at how little disruption the process causes. In general, your personnel will spend 10 – 20 hours spread over several people (15 – 45 minutes from each person). Clients that are better organized and willing to assist us in upfront planning generally spend less time.
R&D with Source Advisors
Companies of all sizes and across multiple industries meet the Federal Government’s test for innovation. At Source Advisors, we will help your company identifies and document qualifying activities to claim the credits you are due.
Find out if your company qualifies for the R&D tax credit .