R&D Tax Credits – Complete R&D Tax Credits Guide

Most businesses do not want to overpay taxes, especially if their business is eligible for R&D tax credits.

Why companies are overlooking the opportunity to get some tax relief?

It is because Research & Development tax credits is a confusing process. Most people can’t understand it well. Moreover, without any, technical knowledge, eligibility criteria, expected benefit the whole process can cause troubles for businesses. There are some companies out there that are simply unaware of this tax credit itself. 

This article will help you find out insights into US R&D tax credits. How it works ? How you can claim for such tax relief.

If you are from the UK please check our UK R&D Tax relief guide

What is R&D tax credits?

R&D tax credits is a tax relief granted to some companies to encourage research and development activities . Such as improving products, designing new products, processes, or software. It was first introduced in 1981 by the federal government. Later on it was made permanent by Congress in 2015 through the PATH Act. 

Only company that meet the criteria can benefit from this relief. In short, it need to include some research and development work.

The R&D tax credits rules are written under section 41 of the internal revenue code. The tax credits is specially designed to be incurred on research associate projects called qualifying research activities. Additionally, companies across all the industries that tend to use scientific procedures to develop and make improvements in existing processes could be eligible. Therefore it is not just for a large corporation, small industries that are eligible can get tax relief for their projects. 

How can a company get benefit from R&D tax credits?

Benefits vary according to the type of business.

For money-making companies, R&D credits go like a dollar for dollar reduction in the federal income tax obligation. Eligible small businesses (ESBs) are the businesses that hold an average of $50m in gross receipt for 3 following years and they can also apply for tax credits against alternative minimum tax liability (AMT). 

On the other hand, qualifying small businesses (QSBs) use some or all of their tax credits to compensate payroll tax obligations over to a maximum of $250000. It is startups or companies less than five years old and has an average of less than $5m gross receipts. So it means your company doesn’t need to be making profits to use tax credits. 

Unused credit can be taken forward for 20 years to apply for future endeavors or taxes. Essentially, companies get back $5-$10 cents for each dollar spent on qualifying expenses.

What qualifies as research and development?

Practices and projects that come under research and development must meet the following four criteria.

Permitted purpose

The research must be relating to innovating or improving the quality, functionality, reliability, or performance of any business component (i.e. process, product, technique, formula, or software).

Technological in nature

The research activity must be from any hard science such as physics, chemistry, engineering biological, and computer sciences.

Elimination of uncertainty

The research project must provide a solution to any problem 

Process of experimentation

The organization must have multiple alternatives for overcoming the uncertainties.

Payroll tax credits

A payroll tax credit means you would have to pay less tax and get more pay. It is made by QSBs specifying the research credit amount that should not exceed $250k. It can be used against the social security liability of the employer. 

How much you can save with R&D tax credits?

With R&D tax credits you can expect 5% to 15% credit back from your total qualifying expenses. All the savings and credit back are monitored by IRS which includes contractor payments, wages, and equipment that is used for the research purpose.  

 How you can calculate Research & Development tax credits?

There are two methods from where you can select your desired method either regular research credit or alternative simplified credit method. 

Form 6765 is given for the process of R&D tax relief and it provides a set of steps for calculating your tax credits using one of the above-mentioned approaches. You can figure out your credits under the methods and then apply for what best suits you. 

What are R & D qualified activities and expenses?

Tax relief is available for only eligible expenses related to qualifying research activities (QRAs). QRAs are those expenses that meet the four-set test designed by the IRS. The four components of this test are permitted purpose, elimination of uncertainty, technological nature, and experimentation process.

Three main types of expenses that are eligible are salaries, supplies or equipment, and contracted research. The qualified expenses can be less than your cash outlay. That means if employees spend their half time on qualifying projects then barely half of their salaries will be numbered as a qualifying expense. 

IRS provides a list of activities and expenses that are non-qualifying such as projects related to management and social sciences and the activities conducted outside the United States. 

How to claim R&D tax credits?

The first step in claiming the tax relief is having the right documentation that includes records that companies already have e.g.

  • Tax and payroll records
  • Reports that track expenses, time, and other accounting information
  • Project records, design drawings, patent applications, and prototypes. 

After you have the proper documentation, you can fill the 6765 form provided by IRS for tax relief to increase your research activities. During this claiming process, they will check if your documentation meets the requirement that comes under Internal Revenue Code Section 41 necessary for a tax credit. 

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Conclusion

Either you are a small company or a big corporation, you can claim R&D tax credits unless you fall under their categories for granting tax relief. In short, If you want to expand your research and development activities and want to innovate some product, you should get benefit from R&D tax credits. The proper documentation process is crucial for applying in it. A percentage of the tax credit would help businesses grow and rise.

 This article has all the information you might need to know about R & D tax credits and how you can avail of this. All the information is presented in a simplified way but if you need further guidance you should contact a potential advisor and professional in the field.

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