R&D Tax Credit Studies
What is the R&D tax credit?
The R&D tax credit is a tax incentive offered by the federal government to encourage businesses to develop new and improved products and processes. The ultimate purpose is to keep the U.S. competitive in the global marketplace.
The R&D tax credit directly addresses the two main challenges businesses face when it comes to research and development—it’s risky and expensive. Research can place a financial strain on a business because it typically requires high-paid staff to conduct it, as well as plenty of dedicated time. Many businesses also find that they must engage third-party research institutions or vendors in order to complete the work. All these things consume precious resources that businesses—especially smaller ones—can struggle to meet. And after all that expenditure of time, money and resources, there’s no guaranteed outcome of success.
That is why the R&D tax credit is available to businesses that perform qualified research, whether or not it had a successful outcome. To qualify, the research activity must seek to solve an uncertainty—in other words, there must be risk.
More good news? Businesses don’t even need to have a formal R&D department to take advantage of the incentives on offer.
An amendment to the Tax Cuts & Jobs Act (TCJA) required that all R&D costs under Section 174 be capitalized and amortized over a five-year period.
As of 1/1/2022 R&D expenses are now required to be capitalized and amortized over 5 years rather than immediately expensed.
Ready to learn more? We’re here for you.
4 Reasons to Pursue the R&D Tax Credit
Improved Cash Flow – The R&D tax credit isn’t a deduction that lowers a company’s taxable income. It is a credit that directly reduces the company’s tax bill by a full dollar for each credit dollar. This makes it a strategic tool for improving cash flow. Businesses claiming these tax credits can expect a significant reduction in their federal R&D tax credit liability.
More Capital for Growth – Less money paid in taxes means more capital for reinvestment in operations or growth. Companies that take advantage of R&D tax credits have a better ability to gain a competitive edge, explore new markets and create jobs.
Carryover to Future Years – The savings from the credit can be so significant that they offset a company’s entire tax liability for the year. The excess credits aren’t refundable, but they aren’t lost. Unused credits may be carried back to the prior tax year or carried forward for up to 20 years!
Claim Regardless of Industry – R&D tax incentives aren’t limited to a particular size or type of business. Any business, small or large, can claim for research and development tax credits, including those from agriculture, architecture, engineering, manufacturing, construction, software development, and more.
Find out how to benefit from R&D tax credits.
By taking advantage of the R&D tax credit, a midwestern software development firm saved more than $700,000 in federal and state income taxes over two years. A midwestern manufacturer of automotive parts has saved nearly $350,000 each year in federal and state taxes by bringing in Tri-Merit to assist with the credit.
Qualifying for the R&D Tax Credit
What kinds of research activities qualify for the R&D tax credit?
The R&D tax credit isn’t limited to major corporations with research arms. It’s open to businesses of all sizes and types as long as they conduct qualifying research activities (QRAs) on U.S. soil. The research activity must seek to solve a technological uncertainty and rely on hard sciences (like engineering, biology, physics, computer science, etc.) The research process must employ stringent testing and experimentation.
R&D tax credit qualified activities:
These rules are contained in the IRS Four-Part Test for Qualifying Business Activity.
The IRS Four-Part Test for Qualifying Business Activity
1. Qualified Business Component.
2. Technological in Nature.
3. Eliminate the Uncertainty.
4. Process of Experimentation.
Businesses that conduct research related to internal-use software (IUS) may also qualify for the R&D tax credit, given that the software being developed will be used for conducting the trade or business. For instance, financial institutions develop specialized software for their operations.
Businesses that develop internal-use software should also satisfy three additional criteria:
- The software must result in reduced company costs while speeding up processes.
- Software development must involve a huge economic risk. It must expend a significant amount of resources and must be subject to the uncertainty of recovery.
- The software should not be commercially available. The business shouldn’t be able to buy, lease, or license the software for its intended purpose without having to make modifications that satisfy the first two criteria.
There are specific exclusions to research and development tax credits, whether the activity is conducted by a small business or a larger corporation. Tri-Merit will go through these exemptions with you.
What kinds of research expenses qualify for the R&D tax credit?
Research expenses that qualify for the R&D tax credit are known as qualified research expenses or qualifying research expenditures (QREs).
- Wages paid to employees who engage in qualified research
- Certain supplies used in the conduct of qualified research
- Contract research amounts paid to a third party to perform qualified research or services (allowed at 65% of the actual cost incurred)
- Basic research payments made to qualified educational institutions and scientific research organizations (allowed at 75% of the actual cost incurred)
Our article on Qualifying Research Expenditures has more information.
The right people, the right process, the right partner.
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