R&D Tax Credit

Qualified Research Activities include but are not limited to the following:

• Design and development of new or improved software applications
• Development of conceptual designs and defining requirements and specifications for new or improved products
• Development of tooling, fixtures, and dies
• Building and testing prototypes
• Development of production processes and equipment
• Evaluation and testing of new materials for product development

The Protecting Americans from Tax Hikes (PATH) Act of 2015 included provisions that allow small and mid-sized taxpayers to offset their Alternative Minimum Tax (AMT) liability with the R&D tax credit for taxable years beginning on or after Jan 1, 2016.

Previously, qualified companies could be limited by AMT and unable to utilize 100% of the R&D tax credit. Instead, any excess credits had to be carried back and then forward. However, the PATH Act makes it possible for small businesses to offset their Alternative Minimum Tax through the R&D tax credit. So for tax years beginning after December 31, 2015, there is no limitation.

The Research and Development (R&D) Tax Credit is a business incentive that can be used to reduce a company’s federal income tax liability. It is available to businesses that are engaged in the development of new or improved products, processes, software, techniques, or formulations. To qualify for this credit, taxpayers must have incurred expenses related to qualified research activities.

There are several benefits to claiming the R&D tax credit. These benefits include:

• Increased cash flow and significant savings
• Reducing your Federal taxable income rate
• Federal and State dollar-for-dollar income tax reduction
• Ability to claim the credit for open tax years going back 3 to 4 years

The R&D Tax Credit is claimed by filing it on a timely submitted tax return, which can include extensions. This credit can also be retroactively claimed on amended tax returns, typically for up to the previous three tax years. To report the credit, businesses need to complete IRS Form 6765, titled “Credit for Increasing Research Activities,” for the tax year in which the qualified expenses were incurred. For business entities such as Sub-S Corporations and LLCs, the credit is passed through to the shareholders, who then report it on their individual Schedule K-1 forms.

There is no limitation on the amount of R&D tax credits that can be claimed each year.

The credit is not refundable. Any Research & Development Credit that is not used to offset the taxpayer’s tax liability for the year in which the qualified research expenses were paid or incurred can be carried back one year. The remaining amount can be carried forward for up to twenty years.

Yes, taxpayers can claim credits for prior tax years. They generally have three years from the original filing date to amend their tax returns. In some cases, the period available for amending may extend beyond three years.

Acquisitions or dispositions of trades or businesses must be accounted for when calculating the R&D tax credit, both for the base period and for the current year’s qualified expenditures. Consistency between these periods is mandated by IRC §41(c)(5). For instance, if a company acquires another entity during the current year, the R&D expenses of the acquired entity must be included in the current year’s R&D tax credit calculation. Similarly, the acquired entity’s prior R&D expenses will also need to be factored into the base period calculations.

Yes, a company calculates its R&D tax credit, and this credit is then directly applied against the company’s federal tax liability for the current tax year in which the credit is claimed. Any unused credits can be carried back one year and then carried forward for up to 20 years.

The IRS has outlined a four-part test in the Internal Revenue Code (IRC) §41(d)(1) that taxpayers must apply to each of their business activities or components. To qualify for the R&D tax credit, all four criteria must be met. Additionally, the company conducting the research must assume the financial risk associated with the development and must also hold the rights to the research being performed.

There are two general methods for calculating the Research Tax Credit:

• The Regular Credit (RC) Method
• The Alternative Simplified Credit (ASC) Method.

Both of these approaches are included on IRS Form 6765, titled “Credit for Increasing Research Activities.” Taxpayers have the option to choose either method when filing a timely tax return. However, it’s crucial to understand the unique advantages and disadvantages of each approach, especially because once a method is elected, it cannot be changed on an amended return.

The first step is to evaluate your ability to utilize the R&D tax credit. Since the credit is not refundable, you need to be paying taxes to benefit from the R&D tax credit process. Once it is determined there is sufficient tax available for your company to benefit from the credit, it is time to proceed to the next step which includes determining the qualifying research expenditures and estimating your R&D tax credit.

The definition of research for R&D tax credit purposes is quite broad. If you are conducting engineering activities that are new to you as a company and there is risk associated with the success of the outcome, this may qualify as R&D.

Some examples include but are not limited to:

• Developing new products or improving existing products
• Experimenting with new materials
• Building and testing prototypes and models
• Developing new or improved software applications
• Testing new concepts
• Developing or improving manufacturing processes.

Any company trying to improve what they do, be more competitive, reduce costs or increase market share will likely have qualifying activities.

Many of our clients have this concern at the outset of the project and are surprised at how little disruption the process causes. Generally, your team would spend between 10 to 20 hours, distributed among several individuals, with each person contributing approximately 15 to 45 minutes. Clients who are well-organized and assist us with upfront planning usually find that they spend even less time on the process.

Yes. For 2016 and subsequent tax years, businesses can use their R&D tax credits to offset payroll tax providing they meet the following requirements:

• Gross receipts 1 for 5 years or less, which means total revenue returns and allowances, including all amounts received for services, income from investments, bank interest, and all other incidental or outside sources.
• Less than $5 million in gross receipts in the year the R&D credit is claimed
• Qualifying research activities and expenditures

Note: For a company wishing to use its 2017 R&D tax credits to offset its payroll tax in 2018, it could not have had any gross receipts prior to 2013.

You should file at the beginning of the year. At WeIncentivize, we can help you file your claim for the R&D Tax credit in a timely manner.