What Qualifies for the R&D Tax Credit?
Many businesses are still unaware that R&D credit eligibility extends beyond product development to include activities such as the latest manufacturing methods, software development, and quality improvements. Even start-ups may be able to utilize the R&D credit against their payroll tax for up to 5 years.
So, if your company does any of the following, your business likely qualifies for the research and development credit:
- Develops or designs new products or processes
- Enhances existing products or processes
- Improves upon existing prototypes and software
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The R&D Tax Credit:
Driving American Innovation
& Job Creation
In this whitepaper, you will learn:
- Which industries and companies are benefiting the most from the R&D credit
- Why changes relating to laws, regulations, guidance, and court decisions have greatly expanded the number of companies that are eligible for the credit
- Why business owners and CPAs tend to overlook the R&D credit in their tax planning and why they need to include it
The Research and Development (R&D) tax credit continues to provide one of the best opportunities for U.S. businesses to reduce their tax liability substantially. Companies from almost all industries can qualify for this government-sponsored tax benefit just by performing their day-to-day activities. This government-sponsored tax incentive, as prescribed in 26 U.S.C. § 41, may be claimed by taxpaying businesses that develop, design, or improve products, processes, formulas, or software.
The credit was introduced in 1981 to increase technical jobs in America by encouraging businesses to invest in innovation. It is calculated based on the wages of the employees performing the qualifying work, making it the most valuable, permanent tax incentive available to American businesses. Furthermore, it can be claimed at the federal and state levels, with over 30 available state credits.
This works for businesses of all sizes, not just major corporations with research labs. What constitutes R&D concerning the credit is much more expansive than business owners realize.
Several factors go into claiming the research and development tax credit. Companies may claim the credit for both current and prior tax years, and documenting their R&D activities can help ensure that they are eligible to claim the credit for all open years.
Businesses need to continuously evaluate and document their research activities to authenticate the costs incurred for each qualified research activity. While some estimations may be involved, they must have a genuine basis for the assumptions used to create those estimates.
Examples of documentation include:
- Payroll records
- General ledger expense detail
- Project lists
- Project notes
- Documents produced through the normal course of business
These records, coupled with credible employee testimony, can form the basis of an R&D tax credit claim. Our comprehensive process can quickly identify and gather this information to substantiate your claim, ensuring you receive the total value you are entitled to under relevant I.R.S. guidelines and Treasury regulations.
Wage, supply, contractor, and computer costs are the major buckets that form the basis of an R&D credit claim.
Established in 1981, the Research & Development tax credit has gradually evolved, with new legislation, regulations, and judicial precedent expanding the number of businesses that can benefit from the credit.
The most impactful changes have occurred within the last two decades.
With the removal of the Discovery Rule, a new and much more favorable standard was introduced, which stated that research activities no longer had to be “new to the world“ but only “new to the taxpayer. “
The Protecting Americans from Tax Hikes (PATH) Act made the R&D credit permanent so businesses could rely on it every year!
The IRS now requires documentation be sent with an R&D credit claim. Luckily, alliantgroup has always prepared this information for clients. For a claim to be valid, taxpayers must provide the following:
- Identify all the business components to which the credit can be applied that year;
- Identify all research activities they’ve conducted and name the individuals who led, supervised, and supported each research activity, as well as the information each individual sought to discover; and
- Identify the total qualified employee pay expenditures, total qualified supply expenses, computer rental costs, and total qualified contract research expenses for the claim year. These costs are reported on Form 6765 (Credit for Increasing Research Activities).
Small and medium-sized businesses make up over 99% of all U.S. businesses in the U.S. When big players like Google, Apple, and other large companies are the only ones thriving, our economy is not in a good place. In 2021, the new COVID relief bill expanded the guidelines to help more businesses qualify. Even if you are in losses or do not have a tax liability, you can still benefit.
Start-ups and small businesses may qualify for up to $1.25 million (or $250,000 each year for up to five years) in the federal Research and Development tax credit to offset the Federal Insurance Contributions Act (FICA) portion of their annual payroll taxes.
To be eligible, a company must:
- Have less than $5 million in gross receipts for the credit year; and
- Have no more than five years of gross receipts.
Yes! The Protecting Americans from Tax Hikes (PATH) Act of 2015 leveled the playing field among companies, irrespective of size, allowing start-ups and small corporations alike to mitigate alternative minimum tax (AMT) limitations against the R&D tax credit.
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