Beginner’s Guide To R&D Tax Credit
The Research and Development (R&D) Tax Credit is one of the best opportunities for companies to considerably slice down their tax liabilities and save thousands of dollars. Research & Development Tax Credit (26 U.S. Code §41) is a federal benefit that provides qualified businesses from a wide range of industries with tax savings. Qualified companies can use this valuable incentive to grow their business.
Over the years, this act has undergone several modifications and expansions. Today, it offers great benefits to a number of companies in the US. However, unfortunately, not all companies fail to reap the benefits of R&D Tax Credit because of some common misconceptions associated with it. These misconceptions mostly revolve around how to use this credit, credit expenditures, eligibility criteria, and documentation.
In this article, we shed light on the current status of R & Tax Credit that will help you gain clarity around these topics that will provide a solid foundation for understanding R&D Tax Credit in a better way and eventually cutting down your company’s tax liabilities.
What Is the R&D Tax Credit?
As prescribed in 26 U.S.C. § 41, tax-paying businesses can claim R&D Tax Credit. These tax-paying companies must deal in the development, design, or improvement of software, formulas, processes, or products.
Companies can get R&D Tax Credit at both the state and federal levels. In the US, more than 30 states provide credit to balance state tax liabilities.
How Does My Company Qualify for R&D Tax Credit?
The eligibility criteria for R&D Tax Credit is vast and can be confusing for some companies. What many companies fail to realize is that it does not only apply to product development but also company operations and activities. Such operations can include the following:
- Quality enhancement operations
- Software development
- Manufacturing processes
Even the startups can qualify for R&D Tax Credit against the payroll tax for up to 5 years.
If your company satisfies the following conditions, it can be eligible for the R&D Tax credit:
- Your company hires scientists, designers, or engineers
- Your company is into developing software, prototypes, patents, or processes
- If your company works for improving existing products
- If your company uses its resources to design or develop new and innovative products
What Are The Benefits Of R&D Tax Credit For Your Company?
R&D Tax Credit offers many benefits for your company. They include the following:
- It improves the cash flow
- Improves your earnings-per-share
- It gives you 12 to 16 cents of federal and state R&D tax credits for every dollar (qualified only)
- You can carry forward R*D Tax Credit for up to 20 years
- It helps you analyze the unclaimed credits for open tax years
- You can use R&D Tax Credit against your payroll tax
- It offers a dollar-to-dollar reduction in your state and federal tax liabilities
- It cuts down the effective tax rate
How Do Companies Claim Research & Development Tax Credit?
Claiming the R&D Tax Credit depends on several factors. You need to submit certain documents to back up your claim. Tax experts suggest that companies should aggressively document any activities or developments that want to claim toward research in order to present the expenditure on qualified research activities. You can use the below-mentioned documents for claiming:
- Meeting and project notes that are associated with the research
- Prototypes, drawings, designs, patents, and blueprints related to the research
- Paid invoices and contracts made with third-party vendors that are also a part of a research
- Accounts, receipts, and expenses associated with the equipment involved in the research
- Payroll details and records of the employees that are a part of your research program
All such records with trustworthy employee testimony can prove to be a reliable foundation for a successful R & D Tax Credit Claim.
Changes To Research & Development Tax Credit Under 2015 Path Act
In 2015, the president signed the PATH (Protecting Americans from Tax Hikes) act. Its impact on R & D Tax credit is significant and business owners are suggested to be aware of the aftereffects of PATH on R & D Credit in its application and availability.
The following are the changes that happened to the R & D Tax Credit because of the PATH act.
R&D Tax Credit AMT Offset
Before the PATH Act, if the company was subjected to AMT regulation, it could not take the advantage of R & D Tax Credit. Post PATH, companies can now offset AMT liabilities through the R & D Tax Credit. Moreover, small businesses can permanently utilize research credits that are generated after 1 January 2016 against AMT and regular tax,
Research & Development Tax Credit Permanence
Before the PATH Act, the R & D Credit used to get extended generally twice a year for 1 to 2 years. This often created a bit of confusion in taxpayers regarding R & D tax credit applications for their upcoming tax returns. It also prevented them from planning tax liabilities offsetting in advance. Post the PATH Act, the R & D became permanent.
R&D Tax Credit Payroll Tax Offset
Before the PATH Act, startups were not able to take direct advantage of the R & D Tax Credit as they could not generate enough income to be eligible for the federal tax liability. The Path Act eliminated this issue and today, startups (with less than 5 million in gross receipts) can offset payroll taxes up to $250,000 from 1 January 2016.
What The Future Holds For The Research & Development Tax Credit
After certain modifications, companies, after 2021, will not be able to offset costs that come under IRC Section 174 research expenses. Instead, they will have to charge research expenses (based in the US only) to a primary (capital) account and deduct those expenses over a period of five years. If the expenses towards research are spent outside the US, those expenses will be charged to a primary (capital) account and can be deducted over a period of a 15-year span.
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