The Research and Development (R&D) Tax Credit has proven to be a significant benefit for businesses to reduce their annual tax liability and reinvest in growth.
While the R&D tax credit has been in existence for nearly 40 years, the 2015 Protecting Americans from Tax Hikes (PATH) Act cleared the way for small and medium enterprises to capture this benefit. Until 2015, the tax credits were only temporary and subject to various restrictions. The PATH Act legislation allowed smaller-sized companies to keep more money in their pockets and increase their bottom line.
David vs. Goliath—R&D Tax Credits Available to the Davids
Small- and medium-sized businesses are discovering the financial benefits of R&D tax credits and are regularly and successfully filing tax credits every year. Using the excess cash to reinvest back into their business to add additional staffing, expanding growth through new and improved products, and implementing processes that otherwise would not be possible without external funding, the PATH Act is breathing new life into research and development.
This influx of capital has led to a more competitive landscape, helping small businesses compete against global giants—ultimately creating a stronger US economy. Estimates vary, but the United States Treasury returns over $10 billion in R&D credits each year to businesses of various sizes.
Aren’t All Businesses Applying for R&D Tax Credits Already?
Not all companies eligible to claim R&D tax credits are doing so because either the leadership is unaware of the benefit or they are overburdened by the complexities of the tax code and the qualification process. It is vital that CPAs representing small and medium business owners are aware of the potential benefits available to their clients.
Additionally, business owners often underestimate the day-to-day activities that meet the definition of qualified R&D under Section 41 of the IRC. These businesses, entitled to an amazing tax benefit, are failing to take advantage of the credit. On the other hand, large companies—such as Amazon and Tesla—continue to use the credit to its fullest potential. As a result, they're significantly reducing, or in some cases, wholly eliminating their tax liability.
But, Isn’t the R&D Credit Only for Research Done in Laboratories?
Definitely not! The biggest misconception is that qualified research must be conducted in scientific laboratories by individuals wearing white lab coats. While scientific research does naturally come to mind when thinking of R&D, it is imperative that our team at Strike meet with you to determine whether your activities are truly R&D expenditures.
The definition of qualified research and development, especially for software development and technology companies, is more inclusive than most realize. Software R&D is the process of developing a product through successive phases in a systematic, iterative methodology—everything from programming to testing, to building frameworks and applications is all included in software development.
Each step in the development lifecycle is conducted to impart new or improved functionality, performance, reliability, or quality to meet a specific set of requirements and specifications. This process takes research, planning, design, development, testing, and implementation, each of which constitutes qualified research activities. The costs associated with these activities are easy to claim with the assistance of the experts at Strike.
How Can I Find Out If My Company’s Software Is an R&D Project?
To be eligible for the R&D credit, each software development project must meet the Four-Part Test. In layman's terms, the software must have a set of requirements and specifications for the development team to meet. At the outset of the project, the team must encounter technical challenges regarding the proper code design or development methodology.
Lastly, the team must utilize a systematic approach to evaluate alternative solutions to each challenge and verify the solution using principles of science. It is also important to generate documentation that will support any R&D credit claim. Strike’s experts are available to do the heavy lifting for you to ensure your credits are substantiated and sustainable.
Where Can These Tax Credits Be Utilized?
The tax credit is an immediate source of cash that can significantly reduce current and future federal and state tax liabilities. Below are a few things to keep in mind:
- Tax credits can be used to reduce federal and state taxes, which a company can carry back up to one year or apply in the current year. They can even be carried forward for up to 20 years.
- Credits can be calculated for any open tax year, typically allowing you to amend the three prior tax years.
- Businesses that meet certain criteria can apply R&D tax credits toward quarterly OASDI payroll tax payments. This benefit is capped at $250,000/year. Companies within the first 5 years of revenue generation with current-year gross receipts less than $5 million can offset their future payroll tax liability.
- Companies can apply the tax credits against the Alternative Minimum Tax (AMT).
If you have any more questions, reach out to us. Our R&D Tax Experts will be more than happy to help you and your company determine how much money you are eligible to save on your tax filings.