The Credit for Increasing Research Activities exists to reward American companies for their investment in research and development activities domestically. Each year, the R&D Tax Credit yields billions of dollars of benefits to companies engaged in qualifying research.
How Does the R&D Tax Credit Work?
The U.S. Credit for Increasing Research Activities, known as the R&D Tax Credit, became law in 1981. This credit helps companies stay competitive. It offers a non-refundable federal tax credit and possible state tax credits. These credits can reduce taxes owed for qualified expenses. U.S. companies can claim the credit by adding up their qualified expenses by category. They must file Form 6765 with their annual tax returns.
For companies in their first five years of business, with less than $5 million in gross receipts, they may qualify for a credit. This credit can be applied to their quarterly payroll tax bill. Companies can earn up to $250,000
Types of Qualifying Expenditures
There are four types of costs that can qualify for a particular R&D project. These costs help support the credit claim. They include employee wages, contractor expenses, supply or material costs, and computer lease or rental costs. Each category’s qualification criteria is set in Internal Revenue Code § 41 (26 U.S. Code §41). This is also explained in treasury regulations and case law.
How are R&D Tax Credits Calculated?
The credit is calculated by comparing the spending in the current tax year to spending from previous years. The most common method is the Alternative Simplified Credit Method. It takes the current year’s R&D spending. Then, it subtracts the average of the last three years. This result is divided by 2. Finally, it is multiplied by a factor of 14%.
These credits are filed and reported on annual tax returns. The deadlines match the statute of limitations. This allows a look-back period of three years for open returns.
If a taxpayer does not have enough tax to use all of a credit in a year, the credit can go back one year. It can also be used for up to twenty years in the future.
Benefits of the R&D Tax Credit
Investing in research and development is vital to innovation, and innovation is the driving force of the American economy. R&D efforts also help create and maintain technical jobs in the United States.
With no limit on R&D Tax Credit funding, U.S. businesses can expect many benefits. They can receive up to $0.14 for every dollar spent on R&D. These benefits might include:
- A reduction in your company’s federal and state tax liabilities.
- Carrying forward money saved to reinvest in further research and development.
- An increase in your cash flow.
- Generating higher company profits and solidifying your business presence.
- Gaining the technological advancements to maintain competitiveness.
Challenges in Claiming R&D Tax Credits
As case law changes, it can be hard for taxpayers to keep up with updates that affect the R&D Tax Credit analysis. It is important to work with R&D tax experts. They help make sure projects qualify and expenses are counted correctly. This also ensures compliance with the relevant laws.
The IRS has made changes to the rules for claiming these credits on amended returns. Now, you must provide a detailed report with five pieces of information about the R&D projects. The five items required are as follows:
- Identify all the business parts defined in IRC § 41(d)(2)(B). These parts support the IRC § 41 research credit claim for the claim year
- All research activities performed by business component
- All individuals who performed each research activity by business component
- All information each individual sought to discover by business component
- The total qualified employee wage expenses, supply expenses, and contract research expenses included on Form 6765
