Research and Development Tax Credit Explained

Filing taxes can be complicated enough for individuals. Still, the process becomes even more frustrating when you’re a business owner, especially a successful one that operates multiple departments within a complex industry. Thankfully, our experts at TaxRobot can ensure you get your business taxes done right the first time through our automated processes. Not only that, but we’ll also help you avoid any pesky audits and increase your chances for more significant tax returns. Please continue to learn everything you need to know about research and development (R&D) tax credits and whether or not your business qualifies for them. And for even more information on R&D tax credits and what they can do for your business, please also consider exploring our range of expertly written, educational articles. 

What is the R&D Tax Credit?

The R&D tax credit is a specific tax credit available to companies that actively develop new or improved business components to enhance functionality, performance, quality, and reliability. Said components typically include products, computer software, processes, techniques, formulas, and inventions. The R&D tax credit is dedicated to businesses at both the state and federal levels, with over 30 states currently offering the credit to help businesses and organizations offset state tax liability. 

What are the Potential Benefits of the R&D Tax Credit?

There are numerous advantages associated with the R&D tax credit. These include:

  • Qualifying for federal and state R&D tax credits, typically ranging from 7 to 10 cents for every eligible dollar spent.
  • Achieving a direct reduction in federal and state income tax obligations, dollar for dollar.
  • Enhancing earnings-per-share.
  • Lowering the effective tax rate.
  • Improving cash flow.
  • Carrying forward the credit for up to 20 years.
  • Conducting look-back studies to identify unclaimed credits in prior tax years (usually 3 to 4 years).
  • Applying the federal R&D tax credit to offset payroll tax for eligible startup companies.

R&D tax credits Eligibility

Eligibility for the R&D tax credit is much broader than many companies realize. It applies to product development and various operations and activities, including software development, manufacturing processes, and quality enhancement operations. Startups may also be able to apply for the R&D tax credit against their payroll tax for up to a maximum of five years. Additionally, your business or organization may be eligible to receive the R&D tax credit if it;

  • Hires designers, scientists, or engineers
  • Works to improve existing products
  • Develops patents, prototypes, processes, or software
  • Devotes time and other resources to create new and innovative products

What is The Four-Part Test?

In addition to the above, any company that encounters and actively resolves technological challenges may be eligible for the R&D tax credit. However, this largely depends on whether the work that the company does meets the criteria established by the following four-part test specified in the Internal Revenue Code (IRC) and Treasury Regulations.

1. Qualified Purpose

The purpose of the research in question must be to create new or improved business components, products, processes, software, formulas, inventions, or techniques that result in new or enhanced performance, reliability, quality, or function.

2. Elimination of Uncertainty

A company must demonstrate that it has thoroughly attempted to eliminate all uncertainty about improving or developing new business components. Uncertainty exists if the information available to the company does not establish the capability or method for developing or improving the business component, or the appropriate design of the business component.

3. Process of Experimentation

Through simulations, modeling, systematic trial, and error, or other methods, a company must demonstrate that it has evaluated one or more alternative solutions for achieving its desired results. 

4. Technological in Nature

The company’s experimentation must rely on hard science, such as chemistry, physics, computer science, engineering, or biology, to meet their end result. However, companies are not expected to exceed, refine, or expand any existing scientific principles to qualify for the credit.

How Can My Business Claim the R&D Tax Credit?

To claim the R&D credit on taxes, businesses should file IRS Form 6765, Credit for Increasing Research Activities. Here’s how:

  1. Gather documentation of qualifying expenses.
  2. Fill out IRS Form 6765 with detailed information.
  3. Include supporting documentation to verify the expenses.
  4. File the completed form with the IRS.

The exact amount of R&D credit that a company can claim on its taxes is dependent on a wide array of factors. Still, the potential savings they can receive will make it worth the time to undergo a thorough investigation. For example, tax credits have the potential to offset income taxes, which can significantly reduce a business’s tax burden for the years that qualified R&D activities occurred. Companies that have not previously taken advantage of the credit can look back on all of their open tax years- typically three to four years- to claim their missed opportunity. 

Businesses can claim the credit by filling out and filing IRS Form 6765, Credit for Increasing Research Activities. As part of this process, businesses need to identify qualifying expenses and provide adequate documentation that shows that the costs in question meet the requirements to qualify for the credit.

What Documentation do You Need to Claim the R&D Tax Credit?

To qualify for the R&D tax credit, companies need to carefully evaluate and document their research activities to establish the number of qualified research expenses paid for each eligible research activity they have undergone. Some of the documentation they will need to provide to qualify for the credit includes;

  • Project lists and notes
  • Payroll records
  • General ledger expense details
  • Emails and other documents produced through the company’s regular course of business

The above records may also need to be combined with credible employee testimony to form the basis of a successful R&D credit claim for any given tax year.

Do R&D tax credits have an expiration date?

The R&D credits under Section 41 of the Internal Revenue Code were permanently extended by the Protecting Americans from Tax Hikes (PATH) Act of 2015. If a business has no tax liability, it can carry forward unused credits for a period of up to 20 years.

How can TaxRobot help me maintain tax credit compliance as laws and requirements change? 

TaxRobot offers a unique blend of expertise, cutting-edge technology, and comprehensive resources to simplify and streamline the process of claiming tax credits. We stay connected with federal, state, and local government agencies, constantly monitoring changes in relevant legislation and compliance standards. This allows us to offer proactive guidance and insights, along with continuous audit support, ensuring compliance and peace of mind for our clients.

Try TaxRobot, Get an R&D Credit of up to $250,000.

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R&D Tax Credits Don’t Have to Be Complicated

Filing business taxes can be a highly complicated and frustrating process, but taking the time to do it correctly and applying for all tax breaks, credits, and benefits that your business may qualify for can be a huge benefit. Now that you have a more thorough comprehension of what goes into qualifying and applying for the R&D tax credit, you can work diligently to ensure that your business receives all of the tax advantages it rightfully deserves. To learn even more about the R&D tax credit and how to effectively apply for it, please consider exploring the quality services offered by our experts here at TaxRobot today!

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