When tax season rolls around, businesses are often on the lookout for anything that will help them save on their taxes. R&D, research and development, tax credits were introduced to encourage companies to innovate and invest in technology.
Any business, regardless of size, that spends on improving their products, software, or processes can qualify for R&D tax credits. Anything developed to improve the quality of a product or process can qualify, not just new products.
The R&D tax credit is available from the federal government, but most states also offer the tax credit. Businesses should review their expenses and learn if anything would qualify for R&D tax credits. R&D tax credits can reduce the tax expenses of a business significantly.
What is R&D Tax Credit?
In the United States, the R&D tax credit was enacted in 1981. The tax credit was created to increase the amount spent by businesses on developing innovations.
The R&D tax credit covers up to 20 percent of the amount paid or incurred by carrying on any trade or business during the taxable year. The R&D tax credit can reduce the income tax liability to $0. A company can also use them against their alternative minimum tax.
R&D tax credits roll over each year, and without tax liability, unused credits can be carried over for up to 20 years. R&D tax credits can be claimed retroactively for up to three years by a business by filing amends for open tax years.
What Research Qualifies for R&D Tax Credit?
Originally, only research focused on developing new products and technology qualified, but that has changed to include most other forms of research. In-house and contract research both qualify, though have different criteria to meet.
In 2003, the removal of the Discovery Rule shifted what research activities qualified for R&D tax credits. This removal allows for a more diverse scope of research and development to qualify and lets more businesses claim R&D tax credits.
In 2015, The Protecting Americans from Tax Hikes Act modified the criteria for the credits, allowing businesses of any size, including start-ups, to qualify. The act also made the tax credit permanent, making it even more beneficial for businesses.
A four-part test exists that lets businesses quickly determine whether their research qualifies. To qualify, research must have these characteristics:
- Technologic in Nature: fundamentally relies on principles of hard science
- Permitted Purpose: must be performed to improve new or existing business components
- Eliminate Uncertainty: performed to eliminate technical uncertainties in the development of a product
- Experimentation: all processes must be completed through experimentation, and every possibility must be evaluated, discussed, or tested
Businesses across many industries may find it beneficial to file for the R&D tax credit, even if only a portion of their research qualifies. R&D tax credit available from states may have different criteria, and businesses should research what qualifies in those areas.
How Does a Business Apply for the R&D Tax Credit?
Businesses claim R&D tax credits by filing IRS Form 6765. A business must identify and document qualifying expenses to file. Various forms of documentation are acceptable, including financial records, technical research documents, and even oral testimony. Filing for state-level R&D tax credit will vary depending on the state and might require different documentation.
There are two methods a business can use to calculate the amount of R&D tax credit they qualify to receive. These methods are known as the Traditional and Alternative Simplified Credit methods.
Using the traditional method, the R&D tax credit will be 20 percent of the current year’s research so long as it is over a base amount. The base amount is calculated off past tax years and can be complicated to calculate. This method is easier for businesses that have claimed the R&D tax credit in the past.
The Alternative Simplified Credit method is the one most commonly used. With this method, a company must first calculate its qualified research expenses over the last three years. Then, it must find the average of their expenses and multiply it by 50%. The business then subtracts that number from the qualified research expense of the current year and multiply the result by 14%
These methods may be complicated to calculate, but many online calculators can make it simpler.
The R&D tax credit can significantly reduce the amount of taxes a business must pay. Learning what research qualifies for the R&D tax credit can be complex, but the criteria are far less strict than most think.
Many businesses may find they have missed out on receiving the R&D tax credit. Luckily, they can retroactively claim unused credit from past years. The R&D tax credit also rolls over into upcoming years. They are a reliable way of lowering expenses.
Several methods are available to calculate the amount of R&D tax credit a business qualifies to receive. The differences between these methods make it easier for new or smaller companies to claim. Businesses of any size may find claiming R&D tax credit beneficial, regardless of industry.
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