As a taxpayer, one of the most daunting and potentially stressful times of the year is April 15th.
Staying in the good books of the IRS is imperative, not only for your finances and the reputation of your business, but also for your mental health and sanity in the process. This is where it pays to stay up to date with the various goings on in the world of taxation.
Lately, there has been a lot of talk surrounding R&D tax credits, and how they can potentially benefit large and small companies alike, regardless of which industry you happen to be involved in.
Of course, we recommend hiring a tax professional or seek our Los Angeles based professional tax services and providers if you wish to familiarize yourself with the intricacies of R&D tax credits, although to help make things that little bit easier, we’ll be looking at some important things to know below.
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Here’s a look at several things to know surrounding R&D tax credits.
First off, what are R&D tax credits?
R&D tax credits (research and development tax credits) were created back in 1981 as a means of stimulating research and development throughout North America.
This is a dollar-for-dollar offset of any federal income tax liabilities, as well as payroll tax liabilities in special circumstances too.
This varies from state to state, but most states provide very similar credits and schemes, which as a result, makes the average potential benefit of the state and federal credit within the range of 10% and 20% of all qualified spending.
In 2019 alone, it is estimated that more than $18 Billion in R&D tax credits were reported by businesses in virtually every industry imaginable.
This particular tax credit equals the total sum of amounts which have been calculated utilizing two unique types of expenses:
- BRPs (Basic Research Payments)
- QREs (Qualified Research Expenses)
If a company is making BRPs or QREs, regardless of whether your activities are successful or not, you may qualify for R&D credits.
Which benefits will I see from R&D tax credits?
So, we’ve looked at what these particular tax credits are, now it’s time to look at which benefits you will see from these particular credits.
- An increase in earnings per share
- Increased cash flow
- Reduced effective tax rate
- Reduced state and federal tax liability
- Increased ROI
Which activities make you eligible?
In order for you to become eligible for R&D tax credits, activities will qualify if they meet each specific element of a four-part test, without being excluded.
The four-part test includes:
First off, the purpose of this first activity is to improve the performance, functionality, quality, or the reliability of a software, product, process, technique, formula, or invention that is designed and intended to be used via the taxpayer’s business, or if it is held for licence, for sale, or for lease.
Here, the taxpayer will encounter uncertainty with regards to whether it can, or indeed how, it should develop the component, or regarding the unique design of the components.
Process of experimentation
Third up, we have process of experimentation. This is designed to eliminate uncertainty as the taxpayer will evaluate alternatives via simulation, modelling, trial and error, and various other techniques and processes.
Technological in nature
Finally, we have the fourth element. In this particular element of the test, the overall success or failure of the unique evaluative process will be determined via the principles of chemistry, engineering, biology, computer science, and other similar hard sciences.
Does your product/research need to achieve or be on path to achieve a major scientific breakthrough in order to qualify?
In a word – No.
This is a common misconception when it comes to R&D tax credits and it is simply not true.
In order to qualify, activities do not need to succeed and achieve a major scientific breakthrough, they instead only need to attempt to discover useful information lacking to a unique taxpayer who is attempting to improve the business.
Which expenses are eligible?
Another common question that people have regarding R&D tax credits is which expenses happen to be eligible in order to qualify.
The following expenses will qualify for R&D tax credits.
Cost of supplies
The cost of supplies utilized in qualified activities including extraordinary utilities and excluding general administrative supplies or capital gains items.
Taxable wages are an expense which will also qualify.
Taxable wages for any employees who happen to perform or directly supervise, or support any qualified activities.
Contract research expenses
Contract research expenses also qualify, though you will not necessarily claim against 100%. Instead, between 65% and 100% of contract research expenses for any qualified activities can be claimed, providing that the taxpayer retains substantial rights to the results of the activity.
They must also pay the contractor whether or not the activity fails or succeeds.
Rental or lease costs of computers
Finally, as computers and IT in general are so pivotal in everyday business life, rental or lease costs of computers and computer systems used in any qualified activities can be claimed against.
Just as an example, payments to cloud service providers for the cost of renting server space is an expense which could be claimed against.
Are there any industry examples of who can benefit from R&D tax credits?
In reality, virtually any Los Angeles based company involved in any industry can benefit from R&D tax credits, provided that they have dedicated resources towards the development of any new products, software, or processes.
Remember, even if their attempts have been unsuccessful, they will still be eligible.
Obviously we won’t list each and every industry and business example because that would take forever and a day. What we can do however, is look at a few common examples, including: Healthcare, life sciences, technology, and manufacturing.
Can start-ups still benefit?
Another common question that people ask regarding this particular scheme, is whether or not start-ups can benefit.
You see, start-ups generally don’t expect to pay any taxes for several years, not unless they are particularly successful from the get-go. Despite this however, they can still benefit.
Start-ups are permitted to use R&D tax credits against up to a maximum of $250,000 of their payroll taxes in five separate fully taxable years, making up a total of $1,250,000 providing that they have:
- Gross receipts for less than $5 Million in that taxable credit year; along with
- No gross receipts for any of the four preceding tax taxable years
What if my company pays alternative minimum tax?
Yet another question that tax professionals are often asked is whether they can claim R&D tax credits if they pay an alternative minimum tax.
The truth is that smaller companies often use these credits up against the AMT (Alternative Minimum Tax) as long as they:
- Are not a public company; and
- Have $50 Million or less in average gross receipts for the preceding three tax years.
How can R&D tax credits be claimed?
If you do wish to claim for this particular tax credit, you will need to gather plenty of support for the credit in which you happen to be legally entitled.
You must report this credit on a federal tax return form filled in in plenty of time, using Form 6765. If the entity reporting this credit happens to be a pass through, the partner or the shareholder will report their share of credits via Form K-1 upon their 1040 returns in order to monetize the credit.
Can I claim the credit for the prior year?
Another fairly common question that our Los Angeles based taxation experts are asked surrounding R&D tax credits is whether or not they can claim the credit for a prior year.
According to the experts, taxation years which are open to amendment under any relevant statutes of limitations can be amended in order to include credits.
Typically, this period is three years from the un-extended due date, or the filing date of the tax return, depending on which is later.
Which activities are excluded from R&D tax credits?
To finish up, we’ll take a look at which activities happen to be excluded from R&D tax credits. These include:
- Reverse engineering
- Foreign research conducted outside of the USA, the Commonwealth of Puerto Rico, or any possession of the United States
- Research related to social sciences, humanities, or arts
- Some software developed for external use
- Research which is funded by any grant, contract, or otherwise via another person or a government entity
- Duplication of existing business components
- Adaption of existing business components
- Research conducted after the beginning of commercial production of the business component
- Surveys, studies, any activity relating to management function/technique, market research, routine data collection, or routine testing or quality control
When to seek professional tax help
If you’re still not sure about the ins and outs of R&D tax credits, or if you simply want to learn more about it, contact our Los Angles based professional tax experts and seek professional help as they will be able to tell everything you need to know.
Get an evaluation today at 1-877-788-2937.