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What is the R&D Tax Credit?

Your daily business operations could offer you many untapped opportunities to lower your tax liability and save money. Startups, small businesses, mid-sized, and large businesses can all take advantage of this opportunity from the IRS called the R&D Tax Credit. 

R&D Tax Credits are a federal (and in many cases state) tax incentive established to promote domestic innovation and production. The tax incentive provides organizations with an additional dollar-for-dollar tax reduction for innovation, design, process improvement, adoption of new business components, and many other common day-to-day activities.

We’ll break down the most frequent questions we get from our clients about R&D Tax Credits, how they work, and who can qualify on this page. 

Book a free consultation with us today to learn more about the R&D Tax Credit and how we can qualify your business for this major money-saving opportunity.

How Does the R&D Tax Credit Work?

R&D stands for research and development. Now, you might be thinking that you need to operate a business in the hard science or medical fields to qualify for a research and development tax credit. But that’s not true. 

Businesses of all sizes and industries can benefit from these tax credits to lower their income tax liability if they create new or improved products, processes, or technology, which we’ll cover in more detail below. Significant federal and state tax credits are available for a range of R&D qualifying activities; however, only 1 in 20 eligible companies take advantage of it.

There’s a good chance that your business is already engaging in some of them. But without applying for the tax credit, you may be paying far more in federal income tax, or even state taxes, than you’re legally required to. 

Another vital thing to remember is that R&D tax credits are expense-driven. So the more you spend on qualifying research expenditures and activities, the more credits you generate and the more money you’ll save on your tax bill. 

Our experienced team of tax professionals can help you identify and implement the most valuable combination of federal and state R&D tax credits to help maximize your returns. For most companies, the credit can be worth 7-10% on qualified research expenses.

Take our FREE ASSESSMENT and find out what you could be eligible for today.

R&D Tax Credit Benefits to Eligible Businesses

Other than saving money on your taxes, our R&D Tax Credit Services can offer a range of benefits for your company, regardless of its size:

  • A higher return on investment
  • Lowered state and federal tax liability
  • A reduced effective tax rate
  • Increased earnings per share
  • Greater cash flow

What companies can benefit?

In theory, any company of any size can benefit from the tax credit. The industry doesn’t matter. What truly matters regarding qualifying for the credit is if the company engages in qualifying activities that meet specific guidelines outlined by the IRS, which we’ll explore in more detail below.

With that in mind, your business could apply for and benefit from R&D Tax Credits if you pay, have already paid, or otherwise expect to pay the following:

  • Federal income taxes
  • Pay for a similar state income tax in one of the states that offer incentives for research and development or research and development-related activities.
  • In some instances, you pay federal payroll taxes.
  • Pay similar state payroll taxes in a state that also provides R&D-related incentives.

The companies that most claim these tax credits are manufacturing companies, at 70% of all R&D tax credit claims. However, millions of companies in the US, from manufacturing to retail and insurance companies, claim the credit every year. We’ve even seen companies in highly niche industries, such as fishing and hunting, successfully claim the credit and lower their tax burdens. 

Also, you don’t have to be raking in millions in sales every year to take advantage of this excellent opportunity. So even if your company is a scrappy new startup with zero dollars in sales and one employee, you can claim significant savings with R&D tax credits.

When was the R&D Tax Credit implemented, and how has it expanded over the years?

The R&D Tax Credit was first established in 1981. Since then, the program has gradually evolved through new pieces of legislation, regulations, and court decisions. Compared to its founding in 1981, the credit has grown to include a much more extensive range of businesses, qualifying activities, and more savings for the companies that apply for the credit. 

The most significant changes have happened in the past 20 years. For example, before 2003, companies had to meet the Discovery Rule, where qualifying activities had to be new to the world. Since 2003, that rule no longer applies. Instead, the rule changed to being new to the taxpayer. This change in the law is much more favorable to companies and makes it easier for them to qualify for the credit. 

The PATH Act, established in 2015, made the tax credit permanent. It also significantly changed what type of businesses could apply, including small businesses, mid-sized companies, and startups.

The R&D Tax Credit Startup Provision

Since the PATH Act was implemented, startups and small businesses can qualify for up to $1.25 million or $200,000 in tax credits for each year, up to five years. This is to offset the Federal Insurance Contributions Act, or FICA, a portion of annual payroll taxes. 

Eligible startups and SMBs must meet the following criteria to qualify:

  • Fewer than $5 million in gross receipts for the credit year
  • Have five years or fewer of gross receipts

How tax reform has fundamentally changed the R&D Tax Credit

The Tax Cuts and Jobs Act of 2017 resulted in sweeping changes and reforms to US taxes. But despite these drastic changes, the R&D Tax Credit has remained one of the most critical and beneficial incentives for US businesses of all sizes and industries.

Can the R&D Tax Credit be used to lower the Alternative Minimum Tax (AMT)?

Smaller companies can use the credit against the AMT if they meet the following criteria:

  • Have $50 million or less in average gross receipts (indexed for inflation) going back three tax years
  • Aren’t a public company

How Much Can Your Company Save with R&D Tax Credits?

Many companies obtain R&D Tax Credits over six figures, providing them with the critical cash needed to reinvest in and grow their businesses.
Our experienced team of tax professionals can help you identify and implement the most valuable combination of federal and state R&D tax credits to help maximize your returns.

For most companies, the credit can be worth 7-10% on qualified research expenses at the federal level. But you can save even more if you apply and qualify for state-level R&D tax credits. You don’t want to be leaving such a large sum of cash on the table.

Many of the companies we work with regularly claim R&D tax credits and put that cash back into their businesses because they improve, develop, or design new products, processes, formulas, or even software.

All of these activities, and many more, can qualify your company for the R&D tax credit.

So, just how complex is the process of applying for an R&D tax credit claim?

It can be quite in-depth, involving intense scrutiny from the IRS. Therefore, it’s vital to have an expert at your side to navigate the submissions process meticulously and to the letter.

There are many misconceptions about what qualifies as R&D. You don’t need to be in a lab coat, and activities don’t need to revolutionize the industry; they just need to attempt to evolve your business. Since the definition has been updated more companies qualify than ever before.

Ryan P. Foley

Partner, Cunningham & Associates

Comprehensive Guide to R&D Tax Credits

rd tax credit guide

1 in 20 eligible companies take advantage of R&D Tax Incentive. This FREE guide contains an executive summary of the tax credit and industry-specific lists of common qualifying activities so you can take advantage of available opportunities.

R&D Tax Credit Success Stories

How Small Businesses and Startup Companies Can Take Advantage of the R&D Tax Credit?

Many SMBs overlook the opportunities available through R&D tax credits. While the number one reason for this lack of action is simply not knowing about these benefits, fear of the complex application process is also a significant deterrent for our clients.

The current tax code and Research and Development Tax Credits offer business owners tons of opportunities to save money and are too often overlooked. With many businesses suffering due to the COVID-19 pandemic, it is crucial more than ever to look at your tax strategy and claim your share.

Our Partner Ryan Foley explains in this video why now is the right time to revisit your tax strategy and take advantage of R&D Tax Credits Services.

What Activities Qualify for R&D Tax Credits?

There are many activities and some expenses that can qualify your business for the R&D tax credit. But the actions have to meet each element of a specific four-part test, which we’ll break down in more detail next.

The IRS Four-part test

The IRS utilizes the following four-part test to define qualified research activities.

Part I: Qualified Purpose

To meet part one of the IRS four-part test, the activity in question must relate to new or improved business components in at least one of the following areas:

  • Function
  • Performance
  • Reliability
  • Quality

The term “business component” means any product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, or license, or used by the taxpayer in a trade or business of the taxpayer. But there is a special rule that applies to production processes and meeting part one of the test.

SPECIAL RULE FOR PRODUCTION PROCESSES

Any plant process, machinery, or technique for commercial production of a business component shall be treated as a separate business component — and not as part of the business component being produced.

Part II: Technological Uncertainty

To meet part two of the IRS test, the business has to be uncertain regarding whether it’s even possible to develop the business component, how it should create the component, or how to design the component appropriately.

Also, the activity must be intended to discover information to eliminate this uncertainty regarding the capability, the method for developing or improving a product or process, or the product design’s appropriateness.

Part III: Process of Experimentation

Part three is closely related to part two of the four-part test. To eliminate the uncertainty required in part two, the business evaluates alternative methods through various means via a process of experimentation. That experimentation can involve the following:

  • Modeling and testing
  • Evaluating alternatives
  • Simulation
  • Confirming a hypothesis through a systematic trial and error
  • Refining or discarding a hypothesis,
  • Or other methods.

Part IV: Technological in Nature

For part two, the activity must be technological in nature and related to the principles of the natural or “hard” sciences — as opposed to the principles of “soft” sciences (economics, social sciences, etc.).

With that in mind, the activity performed must fundamentally rely on the principles of:

  • Physical science
  • Biological science
  • Computer science
  • Engineering

Let’s get into the finer details for activities that can or cannot qualify for the tax credits.

How to Account for the R&D Tax Credit?

Does a business need to have a major scientific discovery or engage in revolutionary research to qualify. No. Unfortunately, this is a major misconception surrounding R&D Tax Credits and leads many companies to forego looking into this excellent vehicle for lowering their tax liability.

The bottom line is, the activities which would qualify your business for the credits don’t have to be a success to qualify. Instead, it’s the act of engaging in qualifying activities in and of themselves that meet the credit requirements.

Generally speaking, the activities just need to attempt to discover technological or scientific information that the taxpayer, i.e., the business, isn’t aware of and is using the information to develop or improve a business component.

So, you don’t need to wear a lab coat and conducting chemistry experiments. Nor do you have to be engaging in activities that will revolutionize your industry with scientific breakthroughs to lower your tax liability with the R&D scheme. You just have to be working on improving your business with methods and processes that meet the four-part test.

How do you determine if your activities meet the four-part test?

Our qualified R&D tax credit experts can help you determine whether your business activities meet the four-part test requirements by conducting an R&D tax credit study.

Examples of Qualifying R&D Activities

Here are a few examples of the activities that could qualify you for the tax credit:

  • Apply for or develop patents
  • Start using equipment that improves a business process
  • Refine and streamline your manufacturing processes
  • Develop software
  • Create new prototypes or models
  • Test new technology or concepts
  • Create new, improved products, processes, or techniques
  • Design for green initiatives
  • Improve your HVAC concept or design
  • Engage in environmental testing

Please keep in mind, this list is not exhaustive. Many different activities could qualify your business. Our R&D Tax Credit experts are highly knowledgeable in this area and can help you pinpoint specific actions within your business that would meet the requirements.

What Expenses Qualify for R&D Tax Credit?

Several expenses can also meet IRS requirements and qualify you for the tax credit. These expenses must be related to the performance of the qualifying activity to quality:

  • Wages — Taxable wages for your employees who perform, supervise, or support the qualifying activity. 
  • Contract research expenses — The taxpayer must have substantial rights to the activity’s results and pay the contractor, regardless of success or failure. 
  • The costs of a computer lease or rental — Any costs related to rented or leased computer use related to improving or developing a business component. 
  • Costs of supplies — Supply costs associated with qualifying activities such as utilities. But this does not include capital items or the cost of general admin supplies.

Claim Your R&D Tax Credit Savings: Reach Out to Us Today.

You’d be surprised (in a good way) at how much money your company can save with R&D Tax Credits. Unfortunately, only one in 20 eligible companies apply for the tax credit. You could be leaving some serious cash on the table.

Size, industry, and profits have no bearing on your eligibility. So whether your company has hundreds of employees or you’ve recently hung out your shingle and are still waiting to make your first dollar in profits, you can still qualify.

Find out today if you do. Schedule a free consultation with us today, and let’s get you qualified!

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