In August 1981, the personal computer revolution was powering up; that’s when IBM released its first PC. This was the catalyst that inspired tremendous innovation in the IT and software arenas. After 2008, there was a major acceleration in the tech industry with an introduction of app-based services, utilization of big data, AI, and machine learning. Consequently, thousands of start-ups popped up, especially in the Bay Area, and began to flourish in this industry.
Imagine if no one jumped in with ideas to improve those initial PCs? Thankfully, innovators saw immense opportunities to make them smaller, more user-friendly, and less expensive – all while adding more RAM. Even within the past ten years, the pace of change continues to pick up speed; IT and software start-ups consistently make valiant attempts to take a commanding lead over their competitors.
According to the San Jose Biz Journal, in 2019, the San Francisco Bay Area tech industry pulled in $45.9B in funding, accounting for 44% of the nation’s tech investments. IT and software start-ups, across the country, have an unrivaled amount of firepower. Many – but not all of these companies – have benefited immensely from the federal government’s Research & Development Tax Credits. Keep in mind whether your research results in significant advancement in technology or turns out to be unsuccessful, you still qualify for R&D Tax Credit.
This is a non-refundable credit that companies are permitted to deduct from their total tax liability – per Internal Revenue Code Sec. 41, To qualify, businesses – ranging from start-ups to well-established – must have research and development-related costs. Since its inception, millions of companies have been capitalizing on this credit annually.
Below are the R&D tax credit basics and the business costs that may qualify. According to IRS guidelines, research will need to:
- Leverage engineering or computer science,
- Develop a new or improved product – or process. This includes software and technology platforms, or
- Utilize an experimentation/testing process to eliminate technological uncertainty.
While information exists on the IRS’ website on Credit for Increasing Research Activities – Form 6765, not every start-up or accountant is aware of the R&D Tax Credit.
Myths abound as to why IT and software companies believe R&D Tax credits are only available for large tech or big pharma power players. This is not entirely true. Below are two other myths that companies erroneously believe:
- Their processes or product improvements don’t qualify, or
- The savings would be too insignificant and not worth the hassle.
The word ‘innovative’ can often make taxpayers hit the pause button. Even if they believe their activities are improving their products or processes, it’s unlikely there will be an industry-wide impact. Just because the development of a new algorithm won’t revolutionize space travel or surpass 5G, it still provides immense benefit to your company. As long as the R&D work companies undertake improves their business, it may be a qualified R&D expense. As you consider filing Form 6765 – Credit for Increasing Research Activities, the best course of action is to conduct a feasibility study. This will help you identify the potential federal – and state – credits that may be available to your tech or software company. Note – this credit can be taken for open tax years, which may result in enormous savings.
As per the latest news, any PPP forgiveness claimed may affect the process of calculating the R&D Tax Credit in 2020. However, if you claim both the employee retention credit and the R&D tax credit in 2020 and/or 2021, the level of details required in your documentation for wages attributable to qualified research activities may have complexities. Small businesses that received a PPP loan may experience a reduction in their ability to claim both federal and state R&D tax credits based on the above. If you are a tech or software company, now is an excellent time to reevaluate your past, current, and future R&D activities.
- Big Changes on the Horizon for R&D Tax Credits as IRS IssuesNew Procedural Filing Requirements - November 18, 2021
- Manufacturing Firms—Don’t Miss Out on Your R&D Tax Credit - April 21, 2021
- How Tech Companies Can Qualify For R&D Tax Credit - February 18, 2021