Listed below are some of the most frequently asked questions our team receives about R&D tax credits
The R&D Tax Credit is a federal and state (most states) tax credit that can result in dollar-for-dollar reduction of taxes owed at year end or potentially against quarterly payroll taxes, for startups. Originally enacted in 1981, under the Economic Recovery Tax Act, the credit expired 8 times and extended 15 times until it was made permanent in 2015 under the PATH Act (Protecting Americans from Tax Hikes). Primarily a labor based incentive, the tax credit aims to promote further innovation by creating positive cash-flows and reducing taxes owed.
The Credit for Increasing Research Activities (the “R&D Credit”) is a government-sponsored tax incentive that rewards companies who conduct research and development in the United States and its territories. The tax credit, originally enacted in 1981 under the Economic Recovery Tax Act, was implemented to incentivize innovation throughout the economy and to keep technical jobs here in the U.S. Finally made permanent in 2015 under the PATH Act (Protecting Americans from Tax Hikes), the R&D Credit is primarily a labor-based incentive to promote further innovation by creating positive cash-flows and reducing taxes owed.
Typically, “Research and Development” implies laboratories, test tubes, and white labs coats. However, the IRS’s definition of R&D is rather broad and can be applied to many industries, including manufacturing, engineering, architecture, food & beverage, and software development.
Any business of any size can claim this tax credit if their R&D activities meet the definition of the 4-Part Test, and if the associated expenditures qualify under IRC Section 41.
R&D credits can be claimed by numerous industries, including software development, manufacturing, life sciences, engineering, architecture, food & beverage, and agriculture. Any company can claim R&D credits as long as the activities meet the requirements of the 4-Part Test below:
The Research and Development Tax Credit is also known as the “Credit for Increasing Research Activities”. As such, the more research expenses a company incurs year over year, the greater the tax credit will be. For all research costs in a given year, a company can expect anywhere from 6-20% in federal credits in addition to state credits, if applicable.
The R&D tax credit is a dollar-for-dollar reduction of federal income or payroll tax liabilities. R&D tax credits can be claimed on amended tax returns which can generate cash refunds from overpayments in those years. Additionally, federal R&D tax credits roll forward for 20 years.
For qualified small businesses (i.e. startups), these credits can be used to offset payroll tax owed to the IRS. Therefore, startups no longer need to be profitable to take advantage of the tax credits.
Most states also have an R&D tax credit available to offset various income tax, franchise tax, or sales and use tax liabilities.
The R&D Credit is a comparative credit, which means that it will depend on the difference between current year QREs and the prior years QREs. The more research expenses a company incurs year over year, the greater the tax credit will be. Typically, a company can expect a benefit of 7-10% of the federal QREs and another 3-20% in state credits (which vary widely from state to state).
To get a better idea of the total tax credit opportunity, use our calculator, or better yet - contact us to speak with one of our R&D experts.
Yes, the federal R&D credit can be carried back one year and forward 20 years. Each state is different when it comes to carryforward and carryback rules, but most follow the general federal guidelines.
For qualified small businesses (or QSB), the federal R&D credit can be used to offset payroll taxes owed to the IRS. Thus, startups no longer need to be in a profitable tax position to take advantage of the tax credits.
To be considered a QSB, a company must meet these requirements:
The definition of qualifying research activities in each state is based on the federal tax credit regulations; however, the calculation methodology varies significantly from state to state. For example:
There are 38 states that currently allow taxpayers to claim an R&D tax credit. Below is the list of states that DO NOT offer an R&D Tax Credit:
Check out our States Pages here (Coming soon) for more information.
For the most part, STRIKE works in a 4-Step Process:
1. Preliminary Analysis (Discovery and Credit Estimation)
2. Credit Calculation
a. Qualitative Analysis: an activities-based analysis to gather and review supporting project documentation) and
b. Quantitative Analysis: Analysis of financial documents to aggregate qualified research expenses (“QREs”) using various methods, including interviews, surveys, questionnaires, and proprietary tools.
3. Documentation and Substantiation of the Credits (deliver of an audit-ready deliverable, including package of our calculation and methods)
4. Audit Support (if the credits were to ever be challenged by the IRS or state, we stand by your side).
Depending on whether a company has previously claimed the R&D tax credit or not, our methods could vary. Also, since every R&D engagement is unique and has varying levels of complexity, some steps can be eliminated or adjusted as necessary.
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 can be selected for audit based on a myriad of reasons. There is no directive that targets companies specifically who claimed R&D credits.
Contrary to public perception, businesses don’t have to have workers in white lab coats and goggles to claim R&D tax credits. Any industry that is designing or developing innovative solutions, software products, formulations, or process improvements that satisfy the 4-Part Test requirements can be eligible as a Qualified Research Expense. The R&D 4-Part Test requirements are summarized below:
Permitted Purpose: In simple terms, the purpose of the activity or project must be to create something new or improved product, process, software, invention, patent, or formula (referred to as a business component). The permitted purpose falls under a broad umbrella that includes improving functionality, performance, reliability, or quality of the business component.
Elimination of Uncertainty: The activities and project in question must attempt to eliminate uncertainty related to the optimal design, development methodology, or component’s capability to achieve the permitted purpose.
Process of Experimentation: Substantially all of the activities constitute elements of a process of experimentation. The activities must include a systematic evaluation of alternative solutions to eliminate the technical uncertainty through, for example, trial and error or a Product Development Lifecycle (“PDLC”).
Technological In Nature: The activities and process of experimentation must rely on the fundamental principles of hard science, including biological sciences, computer science, engineering, physics, or chemistry.
Read More about Qualified Research Expenses (QREs) here.
Yes, the R&D tax credit can be claimed if the federal and state statute of limitations have not lapsed. For federal purposes, an amended return can be filed up to three years from the original filing date. Most states follow the same 3-year statute of limitations; however, some do differ.
The following activities are excluded from R&D tax credits:
STRIKE’s fee is success-based, meaning our client’s have no out-of-pocket costs to capture the credits. We only invoice when you reduce or eliminate current year tax due, or when you receive refunds from amended prior year returns.