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Q. What are Research & Development (R&D) Tax Credits?
The Research and Development Tax Credit is a government-sponsored tax incentive that rewards companies for conducting R&D in the United States. The credit was implemented to incentivize innovation throughout the economy and to keep technical jobs here in the U.S.
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Only available earlier for large corporations, the tax credit is available for startups post 2017’s PATH act from both Federal and State governments (most states).
Q. Does my company qualify for the R&D Tax Credit?
IRS’ definition of what qualifies for Tax Credits is very broad and applies to many industries from software development, manufacturing, wet-lab research, engineering, architecture, food & beverage and finance. Qualified investments for Qualified Research Expenses are required to pass the 4 Part Innovations Test. See Below:
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Permitted Purpose: In simple terms, the purpose of the activity or project must be to create something new or even improve an existing product or service. The permitted purpose falls under a broad umbrella that includes improving functionality, performance, reliability, or quality for a business component. 
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Elimination of Uncertainty: The activities and project in question must attempt to eliminate uncertainty related to design, development method, or components capability.
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Process of Experimentation: The given activity needs to follow at least a rough process of scientific experimentation. The activities must include a process of experimentation of the unknown (uncertainty) that would include testing, evaluating alternatives, or systematic trial and error.
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Technological In Nature: The activities and process of experimentation must rely on hard sciences, such as biology, physics, chemistry, engineering or computer science.
Q. What Expenses can qualify for the R&D Tax Credit?
Wages – Wages of employees involved directly in R&D, as well as employees who are supervising and supporting the direct research.
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Supplies – All supplies and materials used in prototyping and testing of a new or improved product, process, formula, or patent.
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Contract Research – Payments made to a contractor, subcontractor, university or third party for the technical analysis/development of the business component.
Q. What can the R&D tax credit be used for?
R&D Tax credit is an immediate source of cash that can be utilized for a significant reduction in current and future tax liabilities toward Federal and State governments. Below are a few examples:
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Tax credits can be used to reduce federal or state taxes owing, which a company can carry back up to one year or apply in the current year. It can even be carried forward 20 years in case the credits are not utilized. Some of the uses for the Tax Credits are listed below:
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Tax credits can be used to pay the employer portion of the Social Security taxes up to $250,000 or income taxes in case of a profitable company for the same year or the preceding years depending on tax credit expiry.

Alternative Minimum Tax (AMT) if you have less than $50 million in average revenue for the 3 preceding years from the tax year, and you owe AMT in the current year.
Q. How much can I expect to get in R&D Tax Credits every year?
The Research and Development Tax Credit depends on primarily the overall amount invested in qualified research activities. The more research expenses a company incurs year over year, the greater the tax credit will be. A company can expect anywhere from 6-20% in federal credits in addition to state credits which change from state to state. 
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To get a better idea use our R&D Tax calculators or better yet contact us and talk to one of our experts.
Q. Can startups that are/were in losses benefit from tax credits?
Yes, for companies that don’t owe any taxes due to them being unprofitable, the tax credit can be carried back one year and forward 20 years. The tax credit carryforward laws are different from state to state.
Q. Can my company’s chances of Audit increase because of IRS Audits?
No. This is a common misconception among both small and medium businesses. Taking a research credit on a timely filed return, including extension, does not increase your company’s audit risk. According to IRS statistics only 0.9% of corporate tax returns and 0.2% of small businesses (S-corp and Partnerships) are selected randomly.

According to IRS guidelines a return is selected for a number of reasons, including at random. There is no directive that chooses companies specifically who filed for R&D credits.
Q. My company does not have a dedicated research center or laboratory, can I claim credits for software development.
Contrary to widely held belief, businesses don’t have to have researchers working in white lab coats to claim R&D tax credits. Software development or any other innovative service or process development that satisfied the 4 part test to be eligible as a Qualified Research Expense. 

Q. Can the R&D Tax Credit be claimed for a prior year?
Yes, the R&D tax credit can be claimed if the federal and state statute of limitations are open for prior years. For federal purposes, an amended return can be filed up to three years from the original filing date. Most states follow the 3-year statute of limitations; however, some do differ.
Q. What activities are excluded?
The following activities are excluded from R&D tax credits:

- Research related to arts, social sciences or humanities is not eligible for Qualified Research Expense.Foreign research conducted outside the US is not eligible for Qualified Research Expense. This does not include research conducted at the Commonwealth of Puerto Rico, or any possession of the US.
- Adaptation or duplication of existing business components and Reverse Engineering existing products, processes or software.
- Surveys, studies, activity relating to management function/technique, market research, routine data collection, or routine testing/quality control
- Some software developed for internal use, there are exceptions for this exclusion
- Also research funded by any grant, contract, or otherwise by another person (or governmental entity)