Did you know you could earn up to 13.5 cents of Research & Development (R&D) tax credit for every qualified dollar?
If you answered no, you’re not alone. Most companies have either never heard of R&D tax credits, or if they are aware of it, they haven’t filed any claim so far because they assume it is only meant for large corporations or research labs. In reality, thanks to the Protecting Americans from Tax Hikes Act (the PATH Act) of 2015, small companies and start-ups can also reap this tax advantage in their annual tax returns.
We’ve put together a handy guide for you to understand the in’s and out’s of R&D tax credits fully. Let’s take a closer look at what they are and how can they help you save taxes!
What Are Research & Development (R&D) Tax Credits?
R&D tax credit is a benefit that businesses can receive if they invest in designing or developing services, processes, software or products in science or technology. In essence, R&D tax credit is the government’s way of rewarding businesses for investing in innovation.
Has The R&D Tax Scheme Evolved Over The Years?
R&D tax is an initiative that began as a temporary scheme back in 1981. However, in 2015, the PATH Act made the R&D tax credit scheme permanent. Additionally, it included modifications that were appealing to SMEs and also opened up the scheme to start-ups. Congress has eliminated the Alternative Minimum Tax (AMT) bar – this enables businesses to enjoy the R&D tax scheme even more. The hope is that the American economy will become stronger as more businesses invest in increased innovation.
Who Is Eligible To Claim R&D Tax Credits?
As long as your business is investing in research and development activities that help innovation in science or technology, it doesn’t matter what industry sector you belong to – software, biotech/pharma, manufacturing, engineering, food, life sciences, construction, architecture, hospitals, food processing, research organizations, universities, financial services, wineries, warehouse services – the spectrum is quite wide! Even SMEs that sub-contract R&D work are often entitled to claim R&D tax credits.
Why Do Many Businesses Fail To Claim R&D Tax Credits?
Many businesses, especially small, fail to understand the importance of R&D tax credits and do not claim its benefits because:
- The fine print is long and can seem daunting to process
- Writing technical narrative to back claims can be challenging
- An accountant with expertise in R&D is usually required
- Lack of awareness surrounding the Act – most companies assume research has to be successful to claim credits but that’s not true. You do not have to introduce something that’s a major breakthrough. Effort gets rewarded, even without the outcome.
- Failure to realize there is a long list of activities that qualify for this credit, including processes to make a product greener, cleaner, faster, cheaper, automated.
- Lack of awareness that R&D tax claims can date back for 3 accounting years for expenditures that qualify (i.e. retrospective claims)
- Misconception that an in-house research lab is needed to qualify
Quite often start-ups, in particular, don’t realize they might qualify for R&D tax credit even if they don’t produce any profit / taxable income. IF they are considered a qualified small business (QSB), they are eligible to claim a special R&D payroll tax credit that offsets employer FICA taxes with the R&D credit for an annual savings of up to $250,000.
What Are The Eligibility Requirements for R&D Tax Credits?
- Are you trying to discover new information?
- Are you eliminating technical uncertainty?
- Are you trying to enhance an existing product/process/prototype/software?
- Does your research involve experiments?
- Does your research rely on the principles of hard science / engineering and have a qualified purpose?
- Have you engaged the knowledge/expertise of skilled professionals during the project?
What Can Businesses Claim Under the R&D Tax Relief Scheme?
Businesses can claim between 6-14% of R&D expenditure. The exact percentage varies depending on the state they operate in.
How Can You Claim R&D Tax Credits?
You must submit your R&D tax credit claims through your corporation tax return, supporting material may be required for IRS audit. You may claim expenditures related to the development and/or optimization of a product or service, including –
- Salary for employees conducting and supervisors monitoring the R&D activities (only the percentage of time spent on R&D activity, specifically)
- Supply and material-related costs pertaining to R&D (includes prototypes & specialized lab equipment, but NOT general office supplies and depreciable assets)
- Contract costs (if you hired a third-party to conduct research for your organization)
- Computer leasing (if you used cloud services for conducting experiments / research)
Sufficient supportive evidence is imperative for each of your claims – failures, successes / results, designs, meetings, discussion points, actions taken, objectives, etc. should all be tracked in real-time.
What Are Some Tips To Better Document R&D Tax Claims?
R&D tax credit claims are submitted as part of your tax return through form 6765 and 3800. The IRS might interview your technical / financial staff to clarify some points. A tax officer familiar with your particular state’s R&D tax laws will prove very handy in this overall process. Proper documentation and clear understanding of the process will prove imperative in filing your claim – the following best practices will help:
- Demonstrate your R&D activities with records (i.e. lab reports, project lists, project notes, logs, internal emails, patent claims, experiment descriptions, etc.)
- Track your project’s time with an online timesheet – this will document wages pertaining to R&D working hours in a clear manner
- Have contract agreements, invoices and 1099 forms on file, especially if you are subcontracting R&D work – these papers will point to your intellectual property rights
R&D tax credit claim is submitted as part of the tax returns through forms 6765 and
3800. The IRS might interview your technical/financial staff to clarify some points. A tax officer familiar with your particular state’s R&D tax laws will prove very handy in this overall process. Proper documentation and clear understanding of the process can help you file the claim.
Need further advice? Astute has helped many start-ups, pre-IPO companies and global Fortune 1000 companies in claiming substantial R&D tax credits successfully. To find out more, contact us right here.
