Does Your Business Qualifies for the R&D Tax Credit?
What is the Research and Development (R&D) Tax Credit?
The Research and Development (R&D) Tax Credit is a federal benefit that remains one of the best opportunities for businesses to reduce their tax liability while performing activities related to the design, development, or improvement of products, services, or software. This credit provides additional cash to hire additional employees, increase R&D, expand facilities, and this benefit is available across a wide variety of industries.
The R&D Tax Credit is available for businesses of all sizes, not just major corporations with research labs. The R&D credit is substantial, particularly for small and midsize firms. Additionally, for startups businesses that aren’t yet profitable, the ability to apply the credit against up to $500,000 in payroll taxes offers a critical financial benefit when cash-flow is often limited.
What Qualifies for the R&D Tax Credit?
If your company does any of the following, your business 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.
Please note that not all activities qualify for the R&D tax credit. For example, activities such as data collection, market research, cosmetic product improvements, reverse engineering without substantial innovation, and research in social sciences, arts, or humanities are excluded from the credit. In addition, research activities conducted outside the U.S., quality control (QA) testing, and adaptations of existing products without significant improvement are also ineligible. Research activities funded by third parties where the taxpayer does not retain substantial rights or bear economic risk is also excluded.
How do I claim the R&D Tax Credit?
Several factors go into claiming the credit, but the potential savings make exploring the credit a worthy investment. First step is determining if covered activities and expenses qualify for the R&D tax credit. Once that is settled, a business must decide which calculation method they will use – Regular Research Credit vs. Alternative Simplified Credit.
R&D Tax Credit Documentation Requirements
It’s important to maintain but meticulous record-keeping that cam make the process easy to follow. Be sure to gather and retain:
- Payroll records: Document salaries, wages, and time spent on qualified research activities by your staff.
- Expense receipts and invoices: Keep detailed records of supplies, expenses, and third-party services used in R&D, and ensure these are linked to specific qualified research activities.
- Contracts: Maintain legal agreements with third-party contractors involved in R&D projects.
- Technical documents: Include drawings, designs, prototypes, patent filings, and other relevant documentation.
- Project notes: Maintain detailed project records including objectives, experiments, test results, technical challenges, meeting notes, and progress reports.
Filing the R&D Tax Credit Claim
If you’re a small business claiming an R&D payroll tax credit, you’ll file Form 8974 along with federal Form 941. Additionally, to qualify, the small business must be within its first five years of operation and have less than $5 million in gross receipts for the credit year.
If you’re filing for the current year, fill out Form 6765 and file it with your corporate tax return. Indicate whether you are using the Regular Research Credit (RRC) or the Alternative Simplified Credit (ASC) method on Form 6765. Make sure to submit it by the due date of the return, including any extensions.
If you’re claiming the credit for previous years, submit amended tax returns for those open years. Be sure to include detailed information as required by the IRS, such as comprehensive descriptions of your research activities and expenses. Note that generally, you can retroactively claim the credit for up to three years.
Need Help with R&D Tax Credit Claim
Call Tax Credit Group at (563) 583-2115 Click here to submit an online request. TCG tax experts can prepare the forms for tax credits in a matter of days.