Developing new products or services, or just enhancing your present offerings, is one of the surest methods to expand your company. In performing research and development activities, the time and money required can be burdensome whose return on investment risks are falling flat. Considering that investments in new technology, goods, and services are essential to the strength of the economy, it is in the United States government’s best interest to support these endeavors. With this, the R&D tax credit comes into the equation at this point wherein this tax credit is routinely rated as one of the most useful credits utilized by businesses to realize substantial tax savings which can be computed either through an R&D tax credit software or manually. Unfortunately, due to a variety of widespread misunderstandings and a lack of knowledge, the credit is grossly underused.
In this article, you will be introduced to what R&D tax credit is, explain how it works and whom it benefits, and explain how to optimize your tax savings by making use of it. This article will also guide you through the necessary documentation information, including the completion of IRS Form 6765.
How Your Company Can Benefit From the R&D Tax Credit
If your company is eligible for the R&D tax credit, you will have some choice over when and how it is used since in the majority of profitable firms, the credit will be used against the company’s income tax liability. For organizations such as startups that have yet to generate a profit, the credit is typically utilized to cover payroll obligations.
The R&D tax credit is often utilized in the following ways to optimize its value to your business:
1. Receiving between 5% and 15% of monies spent on eligible costs.
The R&D tax credit will reimburse around 5% and 15% of your eligible research costs in its most basic form which means that if your firm spent around $100,000 on acceptable research expenses, then you can recover around $5,000 and $15,000.
2. Employing the credit to reduce payroll taxes
Using R&D tax credit to offset taxes from payroll is a frequent way for small businesses to claim the credit and maybe a big boost for your company, thus, for your firm to qualify, your gross receipts for the year in question must be less than $5 million, and receipts from more than five years ago are ineligible.
If your firm satisfies these standards, you can offset up to $250,000 in payroll taxes using the R&D tax credit. By selecting this technique as an option on your income tax return, you will apply the credit to your payroll taxes. You can also utilize the credit’s excess value to offset a portion of your income tax burden if you have been eligible for the tax credit for several years in a row.
3. Looking backward and forwards
If you were eligible for the credit in prior years but did not claim it, you may still be able to get it, you will just have to amend your tax return to include the R&D tax credit thereby allowing you to earn a refund for that particular year.
If the R&D tax credit is more than your actual income tax, it is not refundable, thus companies who have not yet reached profitability but have research and development costs may feel as though they are not receiving the full advantages of the credit. Thankfully, firms may carry over unused amounts of the credit for up to twenty years.
Two Methods of R&D Tax Credit Calculation
After determining that your firm is eligible in claiming R&D tax credits, there are two conventional methods for calculating it as follows:
Method #1: The standard method
By this method, the R&D tax credit will be valued at 20% of the company’s qualified research expenditures over a base amount, which is from a specific percentage and the average annual gross revenues of the preceding four years.
Method #2: The alternative simplified credit or ASC method
Under this method, the R&D tax credit is equivalent to 14% of the company’s eligible research expenditures and more than 50% of its average QRE for the past three years. If no QREs from previous years exist, the credit equals 6% of the QREs for the present year.
When selecting which method is more suitable for you, you can consult with tax professionals who can help you make the right selection, but in general, the ASC technique is slightly simpler for enterprises who are new to claiming the credit.
R&D Tax Credits: The Application and Claiming Process
In determining how the tax credit should be used optimally in order to receive maximum advantage, determining how to claim the R&D tax credit can be a challenging task. With this, below is an outline of how to determine whether you are eligible for R&D tax credits, how you can apply for them, and which papers you will be needing for your claim.
The tax credit for the R&D claim procedure
Getting the R&D tax credit might appear to be a complicated procedure, however, it mainly consists of three steps:
Step 1: Examine your procedures. Internally, you should evaluate the research and development procedures you plan to claim. Which activities did you engage in, and what was their cost? This process entails auditing your accounting and other internal business documentation.
Step 2: Making your case. Once you have a thorough understanding of the R&D activities your firm did, you will build your case by compiling the necessary evidence to serve as proof for the IRS and submitting the appropriate forms, which will indicate the total costs you’re claiming.
Step 3: Utilization of the credit. To claim the R&D tax credit, you must complete Form 6765 and submit it with the federal income tax return for your firm.
Applying Your Federal R&D Tax Credits to Payroll Taxes
Your company’s federal payroll tax can be reduced by offsetting the R&D tax credit thereby making it an effective strategy for new businesses or startup companies, which often have lower tax liabilities and more research costs. For a business to qualify for this type of claim, a business must have less than 5 years of gross revenue with less than $5 million in gross receipts for the year that the credit has been claimed. The R&D tax credit must be applied to your company’s payroll taxes on a timely filed income tax return. The credit will then cover the employer’s part of Social Security payroll taxes up to $250,000.