Qualified small business owners can save come tax time by claiming credits like the R&D tax credit.
We’ll walk you through this complete guide to filing Form 8974, claiming your R&D tax credit, and answer any questions you might have.
Let’s start with the basics and define some of the forms, credits, and terms we’ll discuss throughout this article.
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Table of Contents
What Is Form 8974?
Form 8974 from the IRS is used to determine the tax credit that qualified small businesses (QSBs) can claim to increase their research and development (R&D) activities.
This credit is claimed on the business’s employment tax return, and startups and small businesses can use Form 8974 to determine how much of the credit they can use for either Form 941, 943, or 944, depending on the business.
Related: What Is Form 941? Guide to ERC
Only employers who made elections when filing Form 6765 can file Form 8974. After making an election to claim payroll tax credits, those employers can file Form 8974 alongside Form 941, 943, or 944 to claim their qualified small business tax credit for increasing research activities.
What Is the R&D Tax Credit?
This tax credit is designed to help eligible businesses offset the costs associated with developing or improving components of their business, like processes, products, innovations, and technologies.
To qualify for the R&D credit, businesses must be a QSB and meet several requirements—we’ll cover all of that in the next two sections.
If a business qualifies, then its expenses and activities must also qualify for the credit; they must aim to improve the quality, reliability, functionality, or performance of a process, product, etc., including:
- Updating its manufacturing processes
- Enhancing the quality of a technique or product
- Developing new software
In addition, there are both state and federal R&D tax credits; while only 38 states currently offer the R&D credit, any eligible business can claim it at the federal level.
The R&D tax credit is typically applied against income tax, but eligible startups without income can also apply the credit against their payroll taxes—more on this later.
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What Is a QSB?
To take the payroll credit election and file Form 8974 for the R&D tax credit, businesses must meet the requirements set by the PATH Act to qualify as a QSB.
The PATH Act defines a qualified small business as a corporation or partnership that has fewer than $5 million in gross receipts for the current tax year and has no interest income or gross receipts dating back longer than five years.
We know that can be confusing—let’s look at an example.
If a business wants to claim the R&D tax credit on its 2022 tax return, its 2022 gross receipts must be under $5 million, and it must not have had any gross receipts or interest income before 2017 to satisfy the 5-year requirement set by the PATH Act.
How Does Filing Form 8974 Benefit My Business?
Without filing Form 8974, qualified small businesses can’t get the dollar-for-dollar tax savings to directly reduce their tax liability with the R&D credit.
There are no limits regarding the amount of credit or expenses that a company can claim each year. In addition, if you don’t use the R&D credit immediately, you can carry it back one year or carry it forward for 20 years—if your business qualifies, there’s no downside to filing Form 8974.
The R&D credit regularly provides various businesses with tax liability relief—up to 10% of their annual R&D costs on the federal level.
Can Your Business File Form 8974 for the R&D Tax Credit?
If your business is a QSB that meets the PATH Act requirements and performs qualifying R&D activities, it’s likely eligible for the credit.
However, businesses must also meet the IRS’s four-part test—business activities must be:
- For a qualified purpose: Your research and activities must have the purpose to either create or improve a business component and result in a new or improved quality, reliability, performance, or function. Business components can be products, processes, techniques, formulas, inventions, or computer software—it’s a broad definition that can apply to businesses in almost any industry.
- To eliminate uncertainty: Companies must also demonstrate that they have attempted to eliminate any uncertainty about the improvement or development of the said business component. If the business’s available information doesn’t establish a method or capability to improve or develop a business component, then uncertainty exists. And while many companies have confidence in their abilities to achieve technical objectives and establish methods to find solutions, the design isn’t always established at the beginning of the project.
- A process of experimentation: In addition, companies must demonstrate that they have evaluated multiple alternatives to achieve a specific result through methods like simulation, modeling, and trial and error. This definition is broad and applies to many activities. For example, software development, clinical research activities, and engineering all typically rely on processes that evaluate additional alternatives.
- Technological in nature: Lastly, the company’s experimentation process must rely on hard sciences (physics, biology, engineering, chemistry, computer science, etc.). However, companies are not required to expand, refine, or exceed any existing scientific principles during their activities.
Form 8974 for Startups
The PATH Act also expanded the R&D tax credit to include startups that weren’t making a profit or paying federal income tax.
Startups that qualify based on the two requirements regarding gross receipts listed above can apply for an R&D credit of up to $250,000. However, they must still pass the four-part test, and the credit goes toward their payroll taxes—the employer’s portion of the social security tax.
So, as long as your startup qualifies as a QSB, passes the above test, and has eligible expenses for the R&D credit, you can file Form 8974 along with Form 6765.
Related: Form 943 Instructions Guide
Qualifying Costs for the R&D Credit
Many expenses are eligible for the tax credit; however, administrative and other general costs typically do not count—even if they support qualified research.
We’ll discuss three primary categories of qualifying costs and expenses that eligible companies can claim on Form 8974.
Qualified Employee Wages
For employee wages to qualify under the R&D tax credit, the employees must perform qualified activities, including:
- Directly supporting qualified research (for example, organizing test results)
- Directly supervising qualified research (for example, managing software developers)
- Executing or conducting qualified research (for example, testing a prototype)
In addition, only the time those employees spend on these specific activities counts toward the R&D credit, and employers must provide at least one of the following forms of documentation:
- Payroll registers
- Timer questionnaires
- Meeting minutes
- Employee W-2s
- Time tracking data
- Oral testimony
Qualified Supply Expenses
Tangible items that were not depreciated or capitalized and directly used in research activities are qualified R&D expenses.
For example, the raw materials used to create and test a prototype would qualify as an expense toward the credit.
However, the research facility, general office materials, depreciable equipment, etc., would not be eligible.
Contract Research Expenses
Like qualified employee wage expenses, contract research expenses include any time spent executing or conducting qualified research.
The primary difference, however, is that a third party performs these expenses—not the business itself.
There are two additional requirements for contract research to qualify as an R&D expense:
- Businesses must bear the economic risk of the contractor’s research
- Businesses must maintain the rights to the research done by the contractor
What Documentation Does My Company Need?
Because companies can claim the R&D tax credit for the current and prior tax years, they can benefit from documenting all of their R&D activities to increase the amount of credit they can claim.
And to claim the credit, taxpayers must document and evaluate their research to establish the expenses paid for each qualifying activity.
While businesses can estimate some expenses, there must be a factual basis for how they create the estimates.
Examples of documentation you might need include:
- Payroll records
- Project lists
- Lab results
- Ledger expense details
- Project notes
- Emails and other documents produced throughout the course of business
Combined with employee testimony, having these records on hand can help companies form the foundation of a successful R&D tax credit claim.
How to Claim Your R&D Tax Credit
Know that we’ve discussed how to determine if your company is eligible to get the credit—let’s look at a simple step-by-step guide:
- Does your company or startup qualify as a QSB? Great—keep going!
- Does it perform qualified research activities? Read on!
- Does it pass the four-part test as defined by the IRS? Almost there!
- Gather your qualified expenses and documentation as outlined above
- Fill out and submit Form 6765 with the IRS
- Once approved, fill out Form 8974
- Finally, attach Form 8974 to your Form 941, 943, or 944 and file them with the IRS
Form 8974 FAQs
Now, let’s go over some of the questions we frequently see about Form 8974 and the R&D tax credit:
When Do I File Form 8974?
Claiming your R&D tax credit always starts by completing and filing Form 6765 along with your income tax return. Then, you can establish your payroll credit available by filing Form 8974 and Form 941, 943, or 944 the following quarter.
However, the way you file these forms will depend on your payroll provider.
When Will I Receive the Money From My Credit?
Ultimately, the timing to receive your credit is based on how quickly the IRS works through your filing to process payment.
If you file all of your forms in a timely manner, you’ll likely see the R&D credit in two to three months following the filing of Form 8974.
If I Have a Carryforward Credit, Can I Offset My Tax Liability?
Here’s the great thing about the R&D tax credit: If you established a credit on a prior year’s tax return but didn’t utilize all of it, the remaining amount carries over for you to use against your income tax liability (forwards 20 years or back one year).
Your credits will only expire after that 20 years is up.
However, when it comes to the R&D credit toward payroll tax liability, you can still take advantage of it carrying over, but it will never expire—you can put it toward future payroll liability indefinitely.
Can I Add Multiple Credits On Form 8974?
Yes! On Part One of Form 8974, you’ll find a table that’s designed to track multiple payroll credits from any given time. You can add successive R&D credits on each row—up to five, which is the maximum number of years you can make the payroll credit election.
What If Our Company Didn’t File Form 6765 First?
Unfortunately, if you didn’t file Form 6765 with your annual income tax return, you won’t be able to file Form 8764 and claim the R&D credit.
What If We Filed Form 6765 But Not Form 8974?
Ideally, you want to file Form 8974 the quarter after you file Form 6765. However, if you forget, it’s not typically a significant issue as the credit does not expire. You will, however, have to wait until a later date to use the credit.
Related: Form 944 Instructions Guide
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How Can My Company Claim the R&D Tax Credit?
The amount of credit a company can claim depends on various factors. However, the potential tax savings makes it worth the effort to investigate—they can offset income tax, reducing a company’s tax burden for all of the years they performed qualified research activities.
Knowing what activities and expenses qualify your business for the credit can get complicated quickly. You can track and file everything by hand—or automate it with the experts.
With TaxRobot, claiming your R&D tax credit is as easy as completing three simple steps:
- See if you qualify
- Enter your information
- Collect your credit
Not to mention that you get access to R&D tax credit experts, professional audit defense, and superior documentation.
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