One of the most certain ways to expand your business is to offer new services and products or enhance existing ones. However, the time and money required to perform research and development processes can appear to be a burden that may fall flat in terms of return on investment.
Because investing in new technology, products, and services is critical to the economy’s health, the US government should encourage these developments. That is where the RD tax credits come into play. The research and development tax credit is frequently ranked as one of the most useful credits that businesses use to achieve significant tax savings. Regrettably, due to a variety of widespread misconceptions and a lack of information, the tax credit is often underutilized.
This article aims to familiarize you with RD tax credits, how it works, and who it can benefit.
RD Tax Credits: What is it?
The Research and Development Tax Credit otherwise termed the Credit for Increasing Research Activities, is a business tax credit that assists companies that have invested in research and development to recoup some of their expenditures. The credit was initially implemented as a temporary measure to stimulate economic activity in 1981 but has subsequently become a permanent component of the tax code.
Is Your Business Eligible to Claim RD Tax Credits?
If your business has invested in research and development during the last year, you are likely eligible for the credit. While it is commonly thought that only large corporations qualify for the credit, the RD tax credits are available to businesses of all the different sizes (large, small, or start-ups) and across a wide range of industries. To qualify, your business must have incurred what the IRS refers to as qualified research expenses or QREs.
How A Business Can Benefit from The Research and Development Tax Credit
If your organization is eligible for the RD tax credits, you will have some flexibility in determining when and how to utilize them. For the majority of enterprises that are now profitable, the credit will be applied to the business’s income tax liabilities. For small businesses, such as start-ups, the credit is typically utilized to offset payroll liabilities.
We have outlined a few common strategies for maximizing your business’s RD tax credits benefit below:
- Recouping 5% to 15% of monies spent on qualified expenses
The sum of your refund will vary according to the nature of your business, but in its simplest form, the RD tax credits will reimburse between 5% and 15% of eligible research costs.
- Reimbursement of payroll taxes through the tax credit
Utilizing the RD tax credit to offset payroll taxes is a very typical approach for small firms to claim the credit. This can be a major benefit for your company. To be eligible, the gross receipts for the relevant year must be less than $5 million, and they cannot date back more than five years.
If your business satisfies these criteria, you may use RD tax credits to cover payroll taxes up to $250,000. If you find that you qualify for the credit numerous years in a row, you can also use the credit’s surplus-value to offset some of the income tax due.
- Reflecting on the past and anticipating the future
If you missed claiming the credit in past years while remaining eligible, you might still be able to claim it this year. It is possible to modify your income tax return in the future to include the RD tax credit, which would result in a refund for that year.
Businesses who have not yet achieved profitability but continue to incur research and development expenditures may feel as though they are not receiving the full benefit of the credit – RD tax credits are not refundable if it exceeds your actual income tax. Fortunately, businesses can carry forward unused credit amounts for up to 20 years.
Expenses That Are Eligible for RD Tax Credits
In general, RD tax credits are available for expenses incurred to develop a new product, service, or technology or improve existing ones. To be more precise, the following expenses typically qualify:
- Processes of engineering include design, data collecting and evaluation, and testing.
- Patented technologies development.
- Improving the technologies that power your business, particularly software.
- Prototyping new products.
- Processes of development, even if they are incomplete.
- Patent development.
According to the IRS’s guidelines, there are four major types of research and development costs that qualify as lawful expenses:
- Supplies. Materials used in the research and development process are allowable as expenses, but they cannot be general supplies utilized in the course of normal operations.
- Salary. W-2 taxable salaries paid to employees who participated in, assisted with, or oversaw research procedures may be deducted as expenses.
- Computer-related services. If you rented computers or employed cloud service providers to conduct research or to host software in the development, you could claim these costs.
- Even if certain subcontractor fees are incurred, contract research could still qualify for the tax credit (usually at a reduced rate) as long as you retain substantial rights to its outcome.
How Research and Development Tax Credits Are Calculated
If your business is eligible to claim RD tax credits, there are two basic methods for calculating it, which we will cover below.
The traditional procedure. The RD tax credit will be valued at 20% of the company’s eligible research expenses over a base amount determined by a fixed-base percentage multiplied by the average yearly gross receipts for the preceding four years.
The method of Alternative Simplified Credit. The RD tax credit is about 14% of a company’s qualified research expenditures that exceed 50% of its average QREs over the last three years using this method. If no prior year’s QREs exist, the credit is at 6% of the current year’s QREs.
How do you decide which method to use? Consult with tax professionals for guidance, but in general, businesses who are inexperienced in claiming the RD tax credits will find the ASC method to be relatively easier to use.