As companies across the U.S. lean into domestic innovation and technological advances to allow them to stand out amongst competitors, it is increasingly critical to find revenue savings to ensure long-term viability and profitability. As one of the country’s largest tax incentive, the federal research and development (R&D) tax credit can be a crucial piece of a forward-looking economic plan for startups and established businesses alike. But as with all government regulated programs, it is vital to understand what R&D tax credit is all about, how it can impact your business and what to look for in your tax practitioner.

Essentially, the R&D tax credit was created and designed to encourage innovation and allow companies to receive money back for work that they’re already doing. Many businesses are eligible for the R&D tax credit but don’t realize it. Examples of industries that often qualify include software, biotech, manufacturing, and more. Taking full advantage of the R&D tax credit can mean an increase in cash flow and a decrease in effective tax rate.

Although the R&D tax credit has been in place since 1981, it didn’t become a permanent provision until 2015 with the passage of the PATH Act. Not only did this make the R&D tax credit permanent, but prior to 2015, many startups didn’t take the R&D credit because companies could only take it against income tax, and startups generally don’t have income. The PATH Act allowed companies to take the credit against their payroll tax, so businesses did not need revenue to benefit from the credit—they just needed to hire people. This essentially infused billions of dollars in non-dilutive capital into the system, but many companies remained unaware. The recent Inflation Reduction Act has made the R&D tax incentive even more valuable by doubling the credit, such that beginning with the 2023 tax year startups/young companies with less than $5 million in gross receipts can use the R&D tax credit to offset payroll taxes up to $500,000 per year.

In 2020, according to Tax Foundation, $11.8 billion was claimed in R&D tax credits. That means so many companies are continuing to innovate, using their R&D tax credits to reinvest into their businesses to grow and scale. But there are billions more unclaimed likely due to a combination of perceived complexity, audit concerns, and common misconceptions about applicability to a company’s operations.

It is worth noting that small and medium-size businesses (SMBs) often can benefit from R&D credits but only make up a small portion of the businesses actually utilizing those credits. With a combination of education and collaboration, SMBs may be able to take full advantage of these valuable R&D credits.

Complexities Made Simple

One of the most misunderstood pieces of the R&D tax credit program is who qualifies and how. Many startups that aren’t in scientific or technical industries may assume they don’t qualify. In reality, activities in a wide range of industries can generate qualifying R&D expenditures. These categories might include cosmetics, food and beverage, apparel, telecommunications, and more.

Essentially, businesses considering filing an R&D claim must meet four criteria:

1. Qualified Purpose: Are you developing or improving a product, process, formula, or software?

2. Eliminate Uncertainty: Are you asking questions like, “Can we develop it?” or “How do we develop it?”

3. Process of Experimentation: Are you systematically evaluating one or more alternatives?

4. Technological in Nature: Is your work within physical or biological sciences, engineering, or computer sciences?

Chances are, if your company is doing something innovative, that activity and associated expenses may likely qualify for the R&D tax credit.

Another added layer of complexity comes thanks to amortization. As of 2022, the Tax Cuts and Job Act requires businesses amortize their R&D costs over five years, instead of deducting them immediately, according to the Tax Foundation. This doesn’t change the way a company would qualify for, or file for, the claim, it only impacts the company’s application of the credit. But because it can impact the capital return, tax experts at TriNet’s Clarus R+D can help SMBs navigate the entire process.

Avoiding The “A” Word: Audit

Working with a respected service provider may be the best way for businesses to ensure they are compliant and to help mitigate the risk of an IRS audit when filing comprehensive R&D claims. Some of the factors to consider when choosing a service provider for R&D tax credit claims include:

• Finding a service provider with R&D credit experience

Service providers with extensive R&D experience are necessary to ensure a smooth R&D study process. Without extensive knowledge of required documentation and nuances in the tax code associated with this credit, you may be left vulnerable to an IRS audit. Unfortunately, the IRS has vague guidelines on what constitutes sufficient documentation to claim the R&D tax credit. And, as with most IRS matters, the burden of proof is with the taxpayer. A good rule of thumb is to hold on to all documentation relating to your R&D activities in the event of an audit.

• Transparency is key

Be sure to have a thorough understanding of your provider’s fee structure and contingencies. Make sure the professionals you are working with have a reasonable capped rate, and look for the pros who will tier their rate based on the size/volume of your studies. You should also ask questions about success rate and numbers of audits.

• Accessibility, visibility and collaboration

Ensure that you can access and see the process behind your R&D studies regardless of whether your service provider is using pen to paper or advanced software designed to optimize R&D tax credits. Collaboration is also vital. Your input in the study is critical since the details around the process of developing your company’s technology are needed to support an audit that could come three years down the road. Your provider should look for your input in the study but make the process simple and efficient.

Another key factor is having a system in place that understands and aligns with IRS audit process. Teaming up with a provider that offers advanced software and a team of skilled CPAs can deliver the assurance and confidence needed to take advantage of the R&D credits that go unclaimed each year.

The United States relies on innovation woven throughout all industries. Whether a business is a small startup or an established enterprise, the R&D tax credit exists to further propel the kinds of cutting edge thinking that consumers worldwide depend upon. If it is uncharted territory for now, it doesn’t have to stay that way. By partnering with a respected and knowledgeable R&D service provider, a company can reap the rewards of one of America’s largest tax incentive with minimal risk of audit. It’s never been a better time to start enjoying increased cash flow for long-term business stability, viability and growth.

This year, the IRS is providing certain relief for taxpayers in affected disaster-areas.

Disaster-area taxpayers in most of California and parts of Alabama and Georgia now have until October 16, 2023 to file various federal business tax returns and make tax payments for the 2022 tax year*. More information can be found here. Additionally, relief has been provided for victims of weather-related disasters in some areas of Oklahoma, Indiana, Tennessee, Arkansas, Mississippi, and New York.

Taxpayers in the affected areas may not need to file any extension paperwork, and they do not need to call the IRS to qualify for the extended deadline.

Detailed information on tax relief in disaster areas, disaster assistance and emergency relief for businesses is available on the IRS webpage at this link.

The Clarus R+D team of tax experts is ready to help you claim the R&D tax credit and get the money you deserve. Schedule a free consultation here to get started.

The Inflation Reduction Act is a sweeping $750 billion health care, tax, and climate bill that was signed into law on August 16, 2022. There is a lot of news about this significant legislation and what it’s doing for lowering drug costs and subsidizing clean energy. One topic that isn’t getting enough attention, however, is that this bill is big news for small businesses and startups. To put it simply, the bill impacts the research and development tax credit. It increases the amount of money startups are able to claim, and broadens the scope of what that money can be used to offset.  

A little background 

The R&D Tax Credit was created to encourage and ignite innovation within American businesses. Originally introduced as part of the Economic Recovery Tax Act of 1981, this credit has been extended many times over the years, eventually becoming a permanent tax credit in 2015.

Currently, startups have a unique advantage when it comes to the R&D tax credit. Young companies with less than $5 million in gross receipts and gross receipts for less than 5 years can use the R&D tax credit to offset payroll taxes (primarily FICA) up to $250,000 per year. But only about half of the businesses that qualify actually apply for the credit, oftentimes because they are unaware that they are eligible.

So, what qualifies as research and development? 

Quite a lot, actually. Creating a new formula for your beer? That’s R&D. Manufacturing a new material? That counts too. Developing new e-commerce software? Yep, that’s R&D. There is a four-part test that will generally help you to know if you qualify. Learn more about that here. 

What’s changed with the Inflation Reduction Act? 

This law showed a renewed commitment to innovation and, in particular, to startups and small businesses. There are three main changes to the tax credit that affect these businesses: 

• The credit amount is doubled. 

Yes, you read that right. Doubled. Now, rather than claiming up to $250,000 per year, qualifying startups and small businesses can claim up to $500,000. This can make all of the difference to a small business looking to innovate in their field. 

• The credit can now be applied to Medicare. 

Now, the additional $250,000 can be applied against the employer portion of the Medicare payroll tax liability. This is an expansion from the previous version of the credit which only allowed businesses to offset the Social Security portion of their payroll tax.  

• There is an increase in IRS funding. 

You might be wondering why this matters, or worse, you might assume that it means an increased chance of an audit. The biggest budget increase is to modernize their systems. However, this increase in funding is one more reason to ensure you’re calculating and documenting  your eligible R&D work correctly. Find out more about defensibility.

The bottom line

The Inflation Reduction Act is helping small businesses innovate and advance like never before. Taking advantage of this tax credit can feel overwhelming, but if you select a practitioner with valuable expertise and a proven track record in the R&D arena, you can have peace of mind while getting the credit you deserve for all you do. Clarus R+D is here to help. You deserve to get credit for all you do, and we want to help you get it.

The R&D tax credit could be getting a major upgrade. 

Recently, U.S. Rep. Jackie Walorski (R-Ind.) introduced H.R. 8253, the Fostering Innovation and Research to Strengthen Tomorrow (FIRST) Act. If signed into law at the end of this year, the bill would double the research and development tax credit and allow more small businesses and growing startups to take advantage. 

The proposed increase would affect both the traditional and alternative rates that are used in the calculation of the credit for companies who already have a history of doing R&D. For companies taking the credit under the traditional method, the credit would increase from 20% to 40% of their qualifying spend that exceeds a base amount. The alternative credit rate, which uses a simpler formula, would increase from 14% to 28% of qualifying research expenses.

Businesses that have not yet started R&D activities can still benefit from the proposed legislation. Under the simplified credit approach, businesses that did not have qualifying research expenses in each of the three prior years, would see an increase in their credit from 6% from 14% of R&D spend – more than doubling the amount of the benefit available to claim. 

Early stage companies with little or no income can still utilize these credits by taking them against Social Security payroll taxes. The maximum amount that they can claim would also see a substantial increase: from $250,000 to $500,000. 

The R&D tax credit is already a valuable opportunity for companies to get rewarded for driving innovation in the US. The proposed legislation will make this benefit even greater. If your business develops or improves processes or products, talk to one of our experts today to find out what the credit could be worth to you.

  Talk to an expert

The R&D tax credit was established in the early 1980s as an incentive to stimulate growth in the US economy. But due to the fact it was an income tax credit, it saw little use by pre-revenue startups. In late 2015, the federal government changed the rules about how companies could claim the R&D tax credit. Early-stage companies can now take advantage of this lucrative incentive, up to $250k per year, that traditionally only went to the big guys.

If you’ve never claimed the credit, it’s time to reconsider. Move past any skepticism or misconceptions and use this financial benefit as a meaningful way to fuel your company’s growth.

Still, many startups don’t understand they’re eligible to claim the R&D credit and continue to miss out on money they’ve already earned. At Clarus R+D, we talk to entrepreneurs every day and we’ve heard it all. Here are the top reasons startups miss this non-dilutive funding opportunity.

It sounds too good to be true.

Entrepreneurs expect to work hard for funding, so they can initially be skeptical about this benefit they’ve actually already earned. The R&D tax credit is a legitimate government program that rewards investments in innovation.

I’m not earning any revenue so I didn’t think I qualified for the R&D tax credit.

Companies don’t need revenue to claim the credit, and don’t need to be paying income tax. The credit can be taken as a payroll tax offset, up to $250K per year, by qualified small businesses. You are considered a qualified small business if you have less than $5 million in revenue and are within five years of your first gross receipt.

I don’t have any employees so I didn’t think I could take the R&D tax credit.

Although wages are typically the biggest component of the credit calculation, contracted costs and supplies are also eligible. If you take the R&D credit as a payroll tax offset, but have no payroll, the credit can be carried forward to the next quarterly return. The credit doesn’t expire and continues to be available until it can be fully used against payroll tax.

I’m not a qualified small business so I didn’t think I could claim the R&D tax credit.

While only qualified startups can take the R&D credit against payroll tax, other companies can take it against income tax. This benefit can then be carried forward for a period of 20 years. Credits generated in net loss years can be recorded as Deferred Tax Assets, enhancing your balance sheet and making your company more attractive to potential acquirers.

I might not do R&D work.

There are many different industries and products that qualify for this credit where development activities pass a four part test. Most technology startups, including software companies, qualify.

My work wasn’t incorporated into my end product so I didn’t think it qualified.

The work does not need to be successful to qualify. If you spent time and money working in a certain direction then needed to change, that effort still qualifies.

I already filed my taxes so I thought it was too late to claim the R&D credit.

Although it’s too late the claim the credit as a payroll tax offset, companies can amend their returns to monetize it as an income tax credit—and can even consider performing a ‘look back’ (up to 3 years) to capture unclaimed tax credits.

I thought the cost of an R&D study wouldn’t be worth the benefit.

The concept of an R&D tax credit is simple. The government wants to reward you for investing in innovation. While the concept is simple, a traditional R&D tax study is notoriously complex. The challenge is getting it done right for a reasonable effort and cost. The Clarus R+D software streamlines and automates the process of claiming the R&D tax credit.

Next steps.

The R&D tax credit must be submitted with your annual business tax return. As the taxpayer, you are required to keep documentation showing that your work meets the criteria to qualify for the credit, and that your credit was calculated from your related qualifying costs. Because the IRS continues to see misuse of this credit, it’s important to have solid documentation on hand in case of an audit. Clarus R+D has deep expertise in helping startups with the R&D tax credit—ensuring compliance, simplifying the process, maximizing the benefit, partnering with your tax preparer, and integrating with your payroll provider for easy monetization.

To learn more, contact the Clarus R+D team of tax experts for a free consultation, or use our quick calculator to estimate how much money you could put back in your company’s pocket.

Clarus R+D is proud to announce that the newest version of our R&D tax credit platform was released on May 2. The updated platform features:

• software enhancements
• a cleaner, more streamlined user experience
• better functionality to assist with complex R&D studies

The research and development tax credit is America’s largest tax incentive, but it is extremely underutilized due to its complex nature. Built by R&D tax experts, our platform automates R&D study processes and directly adheres to IRS code. Whether you are completing one study or hundreds, the platform will guide you step-by-step through the process while ensuring you have all necessary documentation to remain IRS compliant. Our expert team is also available for support and guidance along the way. 

Our mission is to ensure that companies of all sizes can realize and optimize the power of the R&D tax credit in order to materially impact their business. We are excited to unveil these platform updates and continue to make the R&D tax credit accessible to innovators across the country.  

For an overview of exciting new features offered in this platform update, watch the video below.

Talk to an expert 

The IRS does not have a reputation for being magnanimous or for allowing you to correct mistakes easily. But when it comes to forgetting the federal R&D tax credit, do-overs do exist.

If the deadline (including extensions) has not yet passed when you discover the missing credit, you can file what’s called a superseding return. This essentially undoes the filing of your original return, allowing you to include the necessary documentation for the R&D credit.

If the deadline has already passed, filing an amended return is your only option. Although an amended return solves a forgotten R&D credit in many cases, it does not help companies that had hoped to offset payroll taxes. When amending, the R&D credit can only be used to offset income taxes.

Moral of the story? Aim to complete your R&D study before the tax deadline and submit form 6765 alongside your company’s original filing. If you’re nearing the tax deadline and unsure of your eligibility, consider extending so you don’t miss the credit entirely or limit your ability to monetize it.

To find out more, schedule a free consultation with Clarus R+D. Our technology-driven solution simplifies R&D studies, maximizes your benefit, and reduces overall fees.

The latest memorandum and guidance from the IRS regarding filing for the R&D tax credit have increased the need for compliance, proper documentation, and having a reliable partner to guide you through the process. 

In October 2021, the IRS Office of Chief Counsel released a memorandum regarding tax filing procedures for companies submitting claims for the credit in order to improve guidance on how to prove their validity. This memorandum significantly expanded the documentation required to accompany the filing of amended tax returns claiming R&D tax credits. 

Furthermore, in early 2022, the IRS updated their FAQs for businesses looking to claim the R&D tax credit. The new update offers additional guidance based on trends of questions that the IRS receives from tax professionals and taxpayers alike. 

One notable addition to the FAQs relates to a taxpayer’s ability to challenge the ruling of an invalid R&D claim in front of the IRS Independent Office of Appeals. If a claim is denied based on a timeliness determination, then it is eligible for an appeal. However, claims that are denied on the basis of being deficient or otherwise not processable are not eligible to enter the appeals process. This emphasizes the importance of precision, timeliness, and proper documentation from the very beginning of an R&D study, since an appeal is not guaranteed. 

As requirements for the processes and documentation of the R&D tax credit continue to evolve, it is more important than ever to have an experienced partner to guide you in making complete, compliant studies.  

At Clarus R+D, we’ve created a unique software platform that allows users to unlock the full potential of the R&D tax credit while remaining compliant with IRS standards. Our experts ensure that your claims are defensible and supported by all required documentation and proof.

Learn more

On October 15, 2021, the IRS issued a Chief Counsel Memorandum regarding tax filing procedures for companies submitting claims for the research & development tax credit to prove the validity of the refund.

These procedures, which went into effect on January 10, 2022, significantly expand the documentation required to accompany the filing of amended tax returns claiming R&D tax credits.

The procedures will result in high tax preparation costs to businesses, which could deter them from claiming credits.

Recently, the American Bar Association (ABA) sent a letter to the IRS emphasizing the increased burden that the compliance procedures have on taxpayers. The ABA stressed that the procedures will result in high tax preparation costs to businesses, which could deter them from claiming credits. They cite the Paperwork Reduction Act of 1995, which requires the IRS to consider the cost-benefit to the taxpayer when complying with filing procedures.

And since traditional firms can charge up to 30% of the R&D tax credit claimed, any added costs and effort could impede qualified businesses from claiming credits to which they are entitled.

While this memorandum brings new requirements and steps to the tax credit process, technology offers a solution to help you navigate the changes without added expense. By using a cloud-based software where all your information is stored in one place, you can ensure you have all documentation to meet the new standards of the memorandum, as well as staying organized if an audit were to occur in the future.

For companies wanting to file claims for the R&D tax credit, it is crucial to be thorough when documenting qualified research activities and expenses. In order to take advantage of this valuable tax credit, you have a responsibility to make sure your claim is defensible and compliant with IRS guidelines.

Clarus R+D can help you claim R&D tax credits without stress or confusion. Our efficient and user-friendly software platform allows you to organize all required documentation so that you are prepared in the event of an IRS audit. We’ve streamlined the process to save you time and money so that you can get back to running your business.

The R&D and ERTC tax credits are incredibly valuable opportunities for businesses of all sizes to save money, and in turn, continue to invest in innovation and development. Recently, the IRS issued an early release draft of instructions for completing Form 6765 (“Credit for Increasing Research Activities”). This draft reflects updated legislation, originally enacted December 2020, that specifically defines the definition of qualified wages, which impacts Lines 5 and 24 of the form. It is important for businesses who are looking to claim one or both of these lucrative tax credits to understand exactly the kind and quantity of wages that can be claimed.

While businesses can opt to claim both credits, ‘double-dipping’ is not permitted.

One of the most important details to note is that while businesses can opt to claim both credits, ‘double-dipping’ is not permitted. A business claiming wages for the R&D credit cannot use those same wages to claim the employee retention tax credit. Similarly, wages used to claim ERTC on Form 5884-A cannot be used again to claim the R&D credit. Businesses looking to claim both R&D and ERTC will need to ensure that there is no overlap between the wages used to calculate the two credits.

The draft instructions for filing Form 6765 can be found here, but it is important to note that both draft forms and draft instructions should not be referenced when filing until they are completely finalized by the IRS.

The IRS is expected to finalize all tax filing forms and instructions by the end of January 2022.

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