By: Nina Desai | 02/03/25
The Federal Research and Development Credit, or R&D Tax Credit allows companies engaged in qualified R&D activity to claim a tax credit for their efforts. This is a lucrative credit as it is a dollar-for-dollar offset of a company’s tax liability. Unfortunately, several businesses are not claiming this credit due to their belief that their work does not qualify for the credit. If your company is developing or improving a software, product or process, it could potentially qualify for the R&D credit and thereby benefit from substantial tax savings.
People often assume that the R&D credit can only be claimed by large companies. In fact, the R&D tax credit is available to companies of all sizes, including small and medium sized businesses.
This is not true for all loss companies. Specifically, the credit can be used to offset the employer portion of Medicare and social security taxes if a company has…
The credit can offset up to $500,000 a year beginning in the first quarter after filing the company’s tax return. This legislation is extremely beneficial for start-ups, as it allows for an immediate cash benefit when cash flow is tight. Additionally, several state R&D credits are refundable or can be used against payroll withholding taxes. For example, the Georgia R&D credit can be used to offset Georgia payroll withholding taxes. It is important to evaluate both federal and state R&D incentives.
For tax years beginning after December 31, 2020, taxpayers are limited to utilizing net operating loss carryforwards for only 80% of taxable income versus the historical 100%. A federal R&D tax credit is a great way to help cover the income tax liability remaining from the 20% of taxable income.
People often believe that R&D requires someone performing work in a laboratory by people in white lab coats. However, the qualifications for the R&D tax credit are much broader and can apply to a variety of industries, including but not limited to:
Companies that develop or enhance products or processes could potentially qualify for the R&D tax credit. The project can be an ongoing project from year-to-year and still qualify towards the credit. Therefore, the credit is available to companies that are either enhancing an existing product or inventing a new product.
Companies that develop or enhance products or processes could potentially qualify for the R&D tax credit. The project can be an ongoing project from year-to-year and still qualify towards the credit. Therefore, the credit is available to companies that are either enhancing an existing product or inventing a new product.
Many believe that the project must be successful to qualify for the R&D credit. The project can ultimately fail or continue into the next year and can still qualify towards the credit. In fact, the policy reason behind the credit is to encourage innovation and to incentivize companies for taking risks which may lead to unsuccessful projects.
Some businesses mistakenly believe that they must incur a substantial amount of expenses to qualify for this credit. In reality, there is no specific threshold for expenses that must be met to claim the credit. While it’s true that the credit amount is based on the qualified research expenses (QREs) incurred during the R&D process, both large and small expenditures can contribute to the credit. Your company may still be eligible to claim the credit as long as your expenses meet the criteria for qualified research activities.
Another common misconception is that these tax credits are limited to select states with robust technology industries, such as California or Massachusetts. However, many states across the United States offer their own R&D tax incentives to promote innovation and economic growth. While the availability and generosity of these credits can vary from state to state, it’s essential for businesses to explore potential benefits in their specific geographic region. Some of these tax credits may complement the federal credit, providing additional opportunities to reduce tax liabilities and support research and development activities. Therefore, it’s advisable for businesses operating in any state to investigate the availability of state-level R&D tax incentives and determine how they can maximize their benefits to support their research and development endeavors.
Some businesses may shy away from claiming R&D tax credits because they believe the process is overly complex and time-consuming. While navigating the intricacies of tax regulations can be challenging, it’s a misconception that claiming these credits is an insurmountable task. Many companies have successfully leveraged these credits with the help of experienced tax professionals who specialize in R&D tax incentives. These experts can assist businesses in identifying qualifying activities, using tools like an R&D tax credits calculator to estimate savings, and preparing the necessary documentation. By staying informed about changes to R&D tax credits and seeking professional guidance, businesses can simplify the process, ensuring they maximize their tax savings opportunities without unnecessary stress.
Eligible Expenses for the R&D Tax Credit
Contrary to common belief, businesses do not need to create entirely new products to qualify for the R&D tax credit. Activities that improve existing products, processes, or formulas may also qualify, provided they involve technical uncertainty and experimentation. Qualifying activities can include developing prototypes, enhancing intellectual property, or redesigning products to improve efficiency or functionality, with eligible expenses encompassing salaries for scientists, engineers, or designers engaged in these efforts, as well as costs for supplies, contract research, and related activities. This makes the credit accessible to companies across a variety of industries, even those without dedicated R&D departments. Businesses that allocate resources to enhancing their offerings or operations, even incrementally, may meet the qualifications, demonstrating the credit’s inclusive nature. By encouraging innovation at all levels, the R&D tax credit serves as a valuable tool for businesses seeking to foster growth and improvement.
Navigating the Application Process for R&D Tax Credits
Filing for R&D tax credits involves completing IRS Form 6765, “Credit for Increasing Research Activities,” which must be submitted with the business’s corporate income tax return. On this form, businesses must select either the Regular Research Credit (RRC) or the Alternative Simplified Credit (ASC) method and ensure all required information is included. If claiming r&d tax credits for previous tax years, companies can file amended returns for the last three open tax years, providing detailed descriptions of their qualifying research activities and related expenses. Small businesses with less than $5 million in gross receipts during the credit year and within their first five years of operation may also claim an R&D payroll tax credit by filing Form 8974 alongside Form 941, the “Employer’s Quarterly Federal Tax Return.”
Documents Needed to Claim the R&D Tax Credit
While comprehensive documentation strengthens a claim, the IRS does not require a strict list of specific records to qualify for the R&D tax credit. Companies should maintain documentation sufficient to substantiate their eligible expenses, including payroll registers, project lists, time tracking data, general ledgers, and design drawings or blueprints. Employee testimony can also serve as supplementary evidence, particularly when detailing the nature of the research activities. By compiling and retaining these types of records, businesses can confidently support their R&D credit claims while aligning with IRS requirements.
Bennett Thrasher’s has tax advisors that specialize in R&D tax credits to ensure companies are maximizing the tax credits available to them. To get more information about the R&D tax credit or to see if your company qualifies, contact Nina Desai for a free consultation.
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