What is the R&D Tax Credit?
The R&D tax credit is a tax incentive available to eligible businesses typically worth 7-10% of qualified research expenses and can be used to offset payroll or income tax liability. The tax credit was initially introduced as a means to spur innovation and promote job growth. Since its introduction in 1981, it has been modified and expanded numerous times. The R&D tax credit is available to businesses that conduct qualified research activity. Given its complexities, it is best for businesses to work with an experienced R&D tax credit professional who has conducted numerous successful research and development tax credit studies. Schedule a free consultation with Clarus R+D to learn more about R&D tax credits or to discuss whether your business qualifies. Its technology-driven solution empowers companies to fuel their growth with America’s largest tax incentive.
R&D tax credit: The history
The Research and Development tax credit is a government-sponsored tax incentive available to companies who conduct research and development within the United States. The credit was implemented as a Congressional response to the decline in research spending which negatively impacted the Country’s economic growth, productivity gains, and overall global competitiveness. The R&D tax credit was initially implemented in 1981 and has since been reauthorized several times.
The R&D tax credit was originally introduced in 1981. The credit was created as an incentive for businesses that drive innovation. The credit was tailored to reverse the decline in U.S. research spending by providing an incentive that was premised on benefiting increases in (as opposed to total) year over year research spending. The credit was initially proposed as a two-year incentive but has remained in the code since its introduction. Activities for qualifying for the credit were limited to creating or producing a product or process that was new to the world according to what was referred to as the “Discovery Rule”. It was originally scheduled to be effective from July 1, 1981, to December 31, 1985. The credit was renewed for two years (January 1, 1986, to December 31, 1988) in a somewhat reduced form by the Tax Reform Act of 1986, and extended for one year through 1989 by the Technical and Miscellaneous Revenue Act of 1988. The Omnibus Budget Reconciliation Act of 1989 effectively extended the credit through 1990, and The Omnibus Budget Reconciliation Act of 1990 did the same for 1991. The TaxExtension Act of 1991 extended the credit through June 30, 1992.
Initially proposed in 2001, and finalized in 2003, were the regulations to eliminate the “Discovery Rule” in qualifying for the R&D Tax Credit. This modification was beneficial to businesses as it expanded what activities could qualify for the credit. Instead of being “new to the world”, activities now only had to be “new to the taxpayer”.
In 2006 the Alternative Simplified Credit (ASC) was enacted, providing additional flexibility to businesses in calculating credit amounts and the ability to change the baseline calculations for the credit.
First proposed in 2013, Section 174 regulation changed the way controlled group credits are allocated amongst members. Later finalized in 2014, Section 174 regulations put into effect that if supply costs are incurred for the development of a pilot model, the ultimate disposition of the pilot model is irrelevant. Additionally, temporary regulations allowed ASC on amended returns for years that a taxpayer had not previously claimed a credit.
In 2015, when the Protecting Americans from Tax Hikes (PATH) Act was adopted, the Research and Development (R&D) credit became a permanent part of the tax code. With the passing of 2015’s PATH Act, business owners were now able to use the innovation tax credit to offset Alternative Minimum Tax (AMT). Before the PATH Act, taxpayers could only use the R&D credit to offset regular tax liability. So, if a taxpayer had a large AMT that was greater than their regular tax, they could not use the R&D credit. If their regular tax liability was just a bit larger than their AMT, they could use credits to reduce the liability down to the AMT level.
Benefits of the R&D tax credit
Many taxpayers assume the R&D tax credit is available only to major corporations conducting tests in research laboratories. This, of course, is not the case. Businesses of all sizes across many industries are eligible to claim the R&D tax incentive as long as they are engaged in qualified research activities. Under the current tax code, any company that develops or improves products or processes may be eligible for the credit. The number of businesses that engage in eligible activities is ever-increasing as are the eligible activities that qualify for the credit. Clarus R+D is your R&D tax credit consultant of choice to help your business take advantage of the research and development tax incentive. A few of the R&D tax credit benefits are outlined below.
- Create a significant reduction to current and future years federal and state tax liabilities.
- Carry forward credit for up to 20 years.
- The R&D tax credit is not a deduction; it is an actual dollar-for-dollar credit against taxes owed or taxes paid.
- Increase earnings-per-share.
- Offset income taxes if you are in a taxable position.
- Offset 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.
- Offset 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.
- Reduce effective tax rate.
- Improve cash flow.
- Potential unrealized resource.
- Taxpayer may be able to expense all such qualifying R&D costs in the year incurred.
- Utilize the federal R&D tax credit against payroll tax (applicable to certain startup companies)
- A business can take the credit for all open tax years, generally the last three or four years plus the current year.
- Additional years may be available if taxpayer is in a net operating loss or alternative minimum tax position.
- Many states have R&D tax credit in addition to the federal credit
Clarus R+D has a team of professionals to help you determine if your business is eligible for the incentive and then work with you to maximize your R&D tax credit benefit.
Taking advantage of the R&D tax credit
Businesses in the United States are battling in an intensely competitive global market. The research and development tax credit is designed to protect American jobs and businesses while spurring ingenuity and innovation. The R&D tax credit helps by allowing you to take advantage of tax credits for the work your business is already doing. Smart businesses are taking those dollars saved via the tax credit and reinvesting in their growth. Many businesses are unaware expenses related to their daily operations could qualify for a dollar-for-dollar tax credit towards their annual income and/or payroll tax liability, irrespective of industry or company size. Additionally, most states offer an R&D tax credit that can supplement the federal R&D tax credit.
For most businesses, the credit is worth 7-10% of qualified research expenses. This is a dollar-for-dollar credit against taxes owed. Plus, it carries forward 20 years. For startups, applying the credit against payroll taxes is a valuable, non-dilutive funding opportunity. Eligible expenses for the R&D tax credit include U.S.-based wages, contracting, and supply costs. Most typically, wages are the largest qualified expense, and there must be a nexus between the expense and qualified project.
R&D tax credit eligibility
For a business to be eligible for the credit, it must engage in qualified research activities. In order for you to accurately assess your business’ eligibility, you need to work with a well-qualified professional R&D tax credit advisor like Clarus R+D. The Clarus team will work with you in conducting an eligibility study. The following four-part test determines whether an activity is considered qualified research and, thus, eligible for the R&D tax credit.
The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component. A business component is defined as any product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.
Elimination of Uncertainty
The taxpayer must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development or improvement, or the appropriateness of the business component’s design.
Process of Experimentation
The taxpayer must undergo a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer’s research activities. Treasury Regulations define this as broadly as conventional implementation of the scientific method to something as informal as systematic trial and error process.
Technological in Nature
The process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement. Research activities that qualify for R&D tax credits must be conducted in the U.S. If your business does any of the following, it likely qualifies for the R&D tax credit:
- Develops or designs new products or processes
- Enhances existing products or processes
- Develops or improves upon existing prototypes and software
Clarus R+D will work with you to help you understand what is considered qualified research for purposes of determining R&D tax credit eligibility.
Claim the R&D tax credit for your business
A number of factors go into claiming the credit, but the potential savings on the table make exploring the credit a worthy endeavor. The R&D tax credit may be claimed for current and prior tax years. As such, businesses need to document their R&D activities to ensure they are positioned to claim the credit. The taxpayer must document how they met the requirements to qualify for the credit and how the credit was calculated. To claim the credit, the taxpayer must contemporaneously evaluate and document their research activities to establish the amount of qualified research expenses paid for each qualified research activity. While taxpayers may estimate some research expenses, they must have a factual basis for the assumptions used to create the estimates. Examples of such documentation 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
- General ledger notes
- Project notes
- Contractor agreement outlining statement of work
- Other documents a company produces throughout the regular course of business
Clarus R+D: What to expect
Here is what you can expect by selecting Clarus R+D as your tax credit consultants:
- Clarus R+D provides a team of professionals with expert credentials able to answer all your R&D tax credit questions.
- Our proprietary software streamlines R&D studies which maximizes your ROI.
- Clarus has expert knowledge of the IRS regulations relating to the research and development tax credit, IRC Section 41, as well as the regulations pertaining to state-specific research and development credits.
- Clarus has extensive experience in recognizing qualified research activities and expenditures.
- Our time-proven methodology has yielded maximum benefits to our clients.
- The Clarus team has helped hundreds of clients claim millions in R&D tax credits.
- We place emphasis on helping growth businesses take advantage of the tax incentive.
- Clarus does the work for you; our web-based app allows you to enter information at your own pace.
- We have extensive IRS and state audit experience and provide our clients with audit support.
- We have maintained an exceptional success rate in applying for the R&D tax credit.
- We work directly with our clients and their respective accounting firm and payroll processor.
- Our process saves valuable time and resources within the engineering and finance departments.
- Our fees are very competitive.
- Our performance, success rate, and unparalleled quality of service result in high client loyalty.
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Schedule a free consultation with our team of experts to learn more. We’ll discuss the R&D tax credit and help you determine if our solution is a fit for your company.
ABOUT CLARUS R+DWith custom software backed by a team of tax experts, Clarus R+D specializes in tax credits for growth businesses. Our technology-driven solution simplifies the process, maximizes benefit, and ensures compliance. We partner with accounting firms, financial advisors, investors, payroll providers, and more.