The Research and Development (R&D) tax credit can result in significant tax savings for small enterprises but there are a lot of business owners who still fail to claim the research and development credit just because they are unaware of it or believe it does not apply to them. It is not necessary to have lab coats as well as test tubes to claim it, and there is already an available R&D tax credit software that you can use. But before that, all that you need to understand about the research and development tax credit is going to be explained in this article.
How is R&D Tax Credit Defined?
The R&D tax credit is intended to incentivize US businesses to increase their expenditures on research and development in the United States. The traditional method and the alternative simplified credit method are two methods for determining whether a business’s actions qualify for the R&D tax credit.
Calculating R&D Tax Credits through the Traditional Approach
Through the traditional approach of calculating R&D tax credit, it is determined as 20% of the company’s qualified research and development costs over a base amount in the current year.
Calculating the fundamental quantity is a time-consuming operation. It is determined using a fixed-base percentage as well as the average annual gross income of the prior four tax years.
Businesses who have not claimed earlier with the R&D credit or that lack the documentation necessary to compute their prior qualifying research costs will likely find the second approach to be more user-friendly.
R&D Tax Credit: The Alternative Simplified Credit Method of Calculation
Determining the research credit using the Alternative Simplified Credit (ASC) approach is a four-step process:
Step 1: Calculate the average qualified research expenses or QREs that have been incurred by the firm over the last three years.
Step 2: That average will then be multiplied by 50%
Step 3: The result of Step 2 should then be subtracted from the current year’s QREs of the firm.
Step 4: The Step 3 result will now be multiplied by 14% to obtain the credit.
There are several states in the United States that have their own R&D tax credit software and these have their own set of limitations and regulations, therefore it is a good idea to check with a tax adviser in your state for you to determine if you qualify for both the federal and state tax credits.
Who are those Eligible to Claim for R&D Tax Credits?
Any firm that incurs costs while striving to create new or better goods or processes on US soil is eligible for the R&D credit.
A straightforward four-part test will assist you in determining if your firm is eligible for the federal tax credit.
- Dispel doubt. You must have conducted a study to ascertain assurance on the development or enhancement of a product or procedure, this means that modifications made merely for aesthetic reasons do not qualify.
- There is some form of experimentation. The operations must incorporate some form of experimentation to address technical ambiguity, like modeling, simulation, systematic trial, and error, or other techniques.
- Of a technological character. The study must be based on the hard sciences, which include engineering, physics, chemistry, biology, and computer science.
- There is a specific purpose for a new or improved product. The activity involved must be one that has the aim of developing a new or improved product or method that can contribute to the improvement of function, reliability, performance, or quality.
Expressly Excluded Activities from the R&D Tax Credit under the Tax Code
As per the IRS Guidelines for Form 6765 (the form needed to claim the R&D credit), the following activities are excluded:
- Conduct research into customizing a current product or procedure to meet the needs of a certain consumer
- Reproduction of a previously existing product or method
- Surveys or research
- Research on some types of computer software intended for an internal purpose
- Research that has been supported by another individual or government organization
What costs may be deducted from the R&D credit calculation?
Determining the R&D credit necessitates that your business proves its “qualified research costs.” These include the following:
- Salaries paid to employees who are actively involved in the management or assistance in the development process.
- The materials that are consumed or used all throughout the development process.
- Expenses that have been incurred in contract research whenever a third party is undertaking qualifying research on behalf of the company.
- The cloud computing service costs or the cost of leasing machines being used for research purposes
A successful product or procedure is not really required to make the expenses eligible for the tax credit, thus, even if your initiative or study is not a success, you will still be able to claim the tax credit.
Special Regulations that Apply to Newly-Formed or Fledgling Enterprises
Although the federal R&D tax credit is really not refundable, if the amount of eligible credit is beyond your tax due, you can roll over the excess credit for up to twenty years. But, when it comes to new businesses that have large research costs but only have minimum or no income tax liability, they can choose an alternative that may help them to reduce their tax liability immediately.
To Conclude
While large enterprises are not the only businesses that are eligible for the R&D tax credit, they are more likely to obtain it since they have an in-house legal and accounting team to assist them in negotiating the limits.
If you’re still confused if the credit applies to your business’s research and development activities, examine the following:
- Are you planning to invent something new? Activities like software development, manufacturing, architecture, engineering, food, or construction, can be eligible when claiming R&D tax credits.
- Do you make identical goods the same way? Your new product or technique need not be innovative to the industry; it simply has to be innovative to your firm. Businesses seldom make the same products year after year. You may be qualified for the credit if your firm does research to enhance the cleanliness, greenness, speed, or cost of your items or processes.
If you responded “yes” to both of the preceding questions, you may opt to see a CPA or other tax professional familiar with the research and development credit.
