Each year, the government provides over $12 billion in tax incentives to thousands of businesses all over the nation.
The R&D tax credit is one of the most lucrative tax incentives today. For the past forty years, it’s been helping businesses save hundreds of thousands of dollars in tax payments, and it can help yours most likely.
However, you might be thinking your business doesn’t qualify. Or, you might not know what the R&D tax credit even is. That’s what we’re discussing. So, keep reading to learn if your company qualifies for the R&D tax credit.
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What Is This R&D Tax Credit?
The R&D tax credit is a tax incentive for businesses developing or improving a product, idea, software, technique, formula, etc.
Your startup may be eligible if it:
- Creates new or original products
- Improves existing products
- Expands processes, patents, prototypes, or software
- Employs or contracts designers, engineers, or scientists
The research and development credit is available in 30 states and at the federal level. It applies to small, mid-size, and large businesses.
Treasury regulations state that the development research must be technological and reveal new information. The Discovery Test (more on that later) helps recognize the new information.
Most importantly, the product or service in development does not need to succeed to qualify for this incentive.
Who Can Claim The R&D Tax Credit?
If you want to claim the R&D credit against your payroll taxes (and not income taxes)Aside from the product, a few other boxes need to be checked to qualify for the R&D credit. Your business must:
- have gross receipts of $5 million or less
- have gross receipts for five years or less
- not be tax-exempt under section 501
If you don’t meet these criteria, you can still take the R&D tax credit against income tax from the business.
Speak to an R&D tax professional about whether your company matches these requirements.
What qualifies as R&D?
If you believe your startup qualifies for the R&D tax credit, let’s define what counts as research and development.
Businesses must pass a four-part test to prove their work qualifies. The parts of the test are:
Part 1: New or Improved Business Component
Establish new, or improve existing, functionality, performance, dependability, or quality of a product, process, technique, invention, formula, or software that the company intends to use in business.
Part 2: Elimination of Uncertainty
Abolish any uncertainty of the developing business component element.
Some questions to ask in this part are:
- What uncertainties did you strive to remove using typical methods? Could they not be removed?
- What work did you do to remove the uncertainties?
- What advancements did you achieve?
Part 3: Process of Experimentation
Overcome the uncertainty using a systemized process and identify alternative solutions. Alternatives can be identified using modeling, trial, error, simulation, etc.
Part 4: Technological In Nature
The research must rely upon the principles of the physical or biological sciences, engineering, or computer science.
There you have it. If you still don’t think you qualify, let’s go over why many companies don’t believe they’re eligible for the R&D tax credit.
5 Reasons Companies Think They Don’t Qualify
It’s easy to think your business doesn’t qualify for the R&D tax credit if it’s not a major tech company or finding a cure for cancer. But don’t sell your business so short. Here are five reasons companies don’t think they’re eligible:
1. They don’t employ staff with engineering or science degrees
It’s easy to think that companies with engineering or science degrees are the only companies eligible for the R&D credit. But what many people don’t realize is that the government wrote the rules of the tax credit to apply to many different industries.
2. They don’t pay income tax
Start-up businesses could be eligible to apply up to $250,000 for up to five years of the federal R&D credit. The reason? It’s to offset the FICA Act portion of their payroll taxes (you must meet the mentioned requirements to qualify).
3. The company isn’t cultivating anything new
Simply put, research and development don’t have to be new. It can be to build on an existing product or service. Plus, it the work only has to be new to the company, and not necessarily new to the world.
4. The company isn’t focused on development or research
A traditional laboratory doesn’t have to be the end-all to the R&D credit. Indeed, most businesses that qualify don’t have elaborate laboratories dedicated to the latest scientific breakthroughs.
5. AMT is the basis of the company
AMT stands for Alternative Minimum Tax. Most companies haven’t reaped the full benefit from the R&D credit because of AMT. However, after 2016, taxpayers subjected to AMT have been able to offset AMT with the R&D tax credit.
The point is not to sell your business short. If, after reading this, you think your business meets the standards for a successful credit claim, let’s review the required documentation for a claim.
What Documentation Is Needed To Claim The Credit?
It’s important to keep documentation of your research and development because the tax credit is for both current and prior years. Some documentation you’ll need to make a claim is:
- Payroll records
- Employee timesheets
- Project management notes
- Technical meeting minutes
- Emails about technical problem solving
- Any expense details and invoices
- Form 6765 filled out for tax filings
Combine these records with the fruits of your labor, and you’ll have the foundation of a proper R&D claim.
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How Could Your Company Benefit From The R&D Tax Credit?
The R&D tax credit slashes a company’s tax liability. That means more money in your business wallet. Plus, there are no limits on expenses and credits claimed each year.
If you can’t spend all your credits, don’t fret. Your credits can carry forward twenty years- just be sure to check with your state.
The bottom line is this: many businesses can claim the R&D tax credit but don’t. Why not see if your startup applies? The worst that can happen is the government says no.
But the best that could happen? $250,000 or more in savings.
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