How to Claim the R&D Tax Credit
If you think your company might qualify for the R&D tax credit, don’t let the potential tax savings go unclaimed — and don’t be intimidated by the thought of an R&D study or documentation requirements. Across a wide variety of industries, qualifying activities can be found. If you’re willing to take a look, you could uncover non-dilutive funding to reinvest in your business and fuel your innovation with these tax savings.
By claiming the R&D tax credit, you have a responsibility to make sure your tax documentation is defensible. The laws and regulations require it and the penalties for not complying can be severe. Too often, we see companies claim the R&D tax credit without creating proper nexus between expenses and projects. Thorough documentation is the answer to this issue. That’s where Clarus R+D can help. Our tax credit software automatically calculates the credit, as well as generates all required documentation. No more stress or confusion about how to properly claim R&D tax credits.
Clarus R+D software automatically calculates your R&D tax credit, as well as generates all IRS required documentation.
What is the R&D tax credit?
The federal R&D tax credit has been around since 1981 but was made permanent by the PATH Act of 2015. This legislation also opened the door for small businesses that were not profitable to benefit from the credit. In addition, new offsets for the alternative minimum tax and payroll tax made way for even more companies to receive a benefit for their research activities.
Generally, large companies account for a significant portion of the overall research performed and the credit dollars claimed each year. Yet, it’s important to note that the R&D tax credit isn’t just for large companies with established R&D departments. Any company that develops new or improved products, processes, or software could qualify under the US tax code – whether developed successfully or not.
How can I monetize the R&D tax credit?
The R&D tax credits can be used to offset:
- Income taxes if you are in a taxable position.
- Alternative Minimum Tax (AMT) if you have average annual gross receipts for the prior three years of $50 million or less, and you owe AMT in the current year.
- Employer portion of Social Security taxes up to $250,000 for each fiscal year if you are a qualified small business. This payroll tax offset allows qualified small businesses to receive a benefit for their research activities regardless of profitability.
Do I qualify for the R&D tax credit?
Regardless of industry, size, or revenue, any business that performs activities meeting the following four tests qualifies for the R&D tax credit:
- Permitted purpose – the purpose of a qualifying project must be related to creating a new or improving an existing business component.
- Technological in nature – work needs to rely on principles of physical, biological, or computer science or engineering.
- Elimination of uncertainty – when work on a qualifying project began there would have been uncertainty related to your capability to create the product or improvement, the methodology you would use, or the correct product design.
- Process of experimentation – the project must involve a process by which you tested alternatives and resolved the uncertainty above.
What expenses qualify for the R&D tax credit?
Taxable wages for employees who perform qualified activities or employees who directly supervise and support those individuals can qualify. A portion of payments for US-based contractors also qualifies. In addition, supplies used in qualified R&D activities, contract research, computer leasing, and cloud-based services could all be eligible for the R&D tax credit. If cloud-based provider activities relate to R&D activities, such as testing or development in the cloud, a portion of payments may qualify.
The federal tax credit can be as much as 10% of the qualified spend. In addition, many states have their own R&D tax credit programs. These states have varying incentive amounts. Some state R&D tax credit programs resemble the federal program governing what types of activities and expenses are eligible.
The federal tax credit can be as much as 10% of the qualified spend. In addition, many states have their own R&D tax credit programs.
What documentation do I need to claim the R&D tax credit?
First off, assess all of your company’s activities for potential eligibility. Then, begin tracking expenses and gathering documentation. Documentation is an important part of protecting yourself in case of an audit. It must be done right to prevent penalties and limit liability.
Documentation should validate that the expenditures claimed are eligible for the credit. It needs to:
- Be dated to prove that the work occurred in the fiscal year you are claiming
- Highlight technical challenges to substantiate that the R&D was done
Documentation can include:
- Version control for all technical documents
- Prototypes, including software and physical products
- Test documents
- Developer or Engineering Notebooks
- Meeting minutes
- Whiteboard photos
- Invoices/ receipts
- Contractor agreement outlining statement of work
What if I don’t have a tax liability?
If you are conducting qualified R&D projects, it’s beneficial to claim the R&D tax credit regardless of your company’s taxable income. R&D tax credits can be carried forward to offset future income tax liability. Typically, credits that can’t be used immediately will carry forward for up to 20 years. Also, companies can often claim the R&D tax credit retroactively by filing amended returns.
Can I offset payroll tax?
Qualified startups can claim up to $250,000 against payroll taxes each year. These businesses can use the R&D credit to offset payroll taxes for up to five years, with a maximum of $1.25 million in total credits used on quarterly federal payroll tax returns. Whether or not your startup is profitable, you may qualify for the payroll tax offset if you have less than $5 million in revenue and are within five years of your first gross receipt. Also, it is important to note that unless you claim with the original filing, you will not be able to take the payroll offset.
What about the Alternative Minimum Tax?
Credits can now immediately reduce a company’s tax liability, freeing up cash that can be reinvested in the company. Companies whose R&D credits may have been limited by the AMT in the past can now use the R&D tax credit to fully offset AMT without regard to tentative minimum tax. Eligible small businesses are sole proprietorships, partnerships, and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years.
What do I need to file the R&D tax credit?
The R&D tax claim needs to be submitted with your annual corporate tax filing. Here are all the necessities:
- Form 6765, Credit for Increasing Research Activities
- Form 3800, General Business Credit. This form has a line that asks for the amount of Credit for Increasing Research Activities.
- Each state will have its own form if it offers a state R&D tax program.
- If you qualify for the payroll tax offset, you will need to make sure you account for it on Form 941, Employer’s Quarterly Federal Tax Return. You will also need to fill out and attach Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities.
- Documentation requirements as stated in I.R.C. § 41
Our team of R&D tax credit specialists is here to help. We partner with business owners in various industries to assist with strategies that can help you optimize the benefit for your organization. Contact us today to schedule a free consultation with one of our tax experts.