Qualifying R&D Expenses
What is the federal Research and Development Credit?
The Research & Development Credit is a business credit that is used to reduce federal income tax. A business taxpayer qualifies for the credit if it paid or incurred qualified research expenses while conducting qualified research activities.
How is the R&D Credit claimed?
Corporations claim the research credit using 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 research credit that can be claimed?
No. There’s no maximum the research credit can be.
Is the R&D Credit a refundable credit?
No. Any Research & Development Credit that is not used to offset the taxpayer’s income tax for the year in which the qualified research expenses were paid or incurred may be carried back to the prior tax year or carried forward for up to twenty years.
Can the research credit be claimed for a prior year?
Yes, as long as the amended return is filed with three years of the original filing date. Note that the 280(C) election regarding the reduced credit cannot be made on an amended return.
How does the acquisition or disposition of a business entity affect the research credit computation?
Acquisition or dispositions of trades or businesses should be identified and verified (from the base period to the current year) to confirm that they are property reflected in the computation. The taxable year’s qualified research expenses (QREs) and the base period years’ QREs are determined based upon the application of the law in effect for the year in which the credit is being claimed. Consistency between these periods is required per IRC §41(c)(5).
Does the research credit provide a dollar for dollar cash savings of federal income tax?
What is qualified research for the purpose of computing the R&D Credit?
Research activity is considered “qualified research” if it meets all of the four tests as described in Internal Revenue Code (IRC) §41(d)(1). In addition to the four tests, the company carrying out the work must bear the financial risk and must retain the intellectual property rights of the business component.
What research activities do not qualify for the R&D Credit?
The following research activities are excluded:
- Foreign research undertaken outside the United States and its territories.
- Research conducted in the social sciences, arts, or humanities.
- Ordinary testing or inspection of materials or products for quality control.
- Market and consumer research.
- Research relating to style, taste, cosmetic, or seasonal design.
- Advertising and promotional expenses.
- Management studies and efficiency surveys.
- Computer software for internal use of the taxpayer, unless it meets additional tests.
- General managerial and administrative duties.
- Accounting tasks (i.e. bookkeeping, A/R, A/P, payroll).
- Customer service support.
- Routine status update meetings.
- Commercial production.
- Giving or receiving training.
- Personnel matters.
- Budget preparation.
- Recruiting employees.
- Charitable fundraising.
- Attending industry or professional conferences.
- Attending partnering and alliance activities and meetings.
- Non-R&D related supervisory functions.
- Internal business process development.
- Research to locate and evaluate mineral deposits, including oil and gas.
- Acquisition and improvement of land and of certain depreciable or depleted property used in research, including the annual depreciation deduction.
- Research conducted after the beginning of commercial production.
- Research related to adaptation of an existing business component including the duplication of existing products, processes, software, techniques, formulas or inventions.
- Research related to duplication of an existing business component from a physical inspection, plans, blueprints, detailed specifications, etc.
- Funded research, including any research funded by any grant, time and materials contract, or otherwise by another person or governmental entity.
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) generally include employee wages, consumed material expenses, and contracted labor costs.