The Research and Development, more commonly known for its shortcut – RD tax credits, can result in significant tax savings for small companies. Too many company owners fail to claim the RD tax credits because they are unaware or wrongly assume it does not apply to them.
It is not necessary to have laboratory gowns and test tubes to claim it. Most, if not all, of what you need to know about the RD tax credits is included in this guide.
What is RD Tax Credits?
The RD tax credits is intended for US businesses to gain a tax incentive to increase their investment with regards to research and development in the United States. If a business’s actions qualify for the RD tax credits, the credit can be calculated in one of two ways.
The credit is calculated using the usual technique as 20% of the company’s eligible research expenditures over a standard amount in the current year.
Calculating the basic amount is a tedious process. It is calculated using a specified percentage and the company’s average yearly gross receipts for the preceding four tax years.
Companies that have not previously claimed the RD tax credits or lack the documentation essential to verify their previous qualified research expenditures would likely find the second technique easier to use.
Alternative Simplified Credit
Calculating the research credit using the Alternative Simplified Credit or the ASC approach is a four-step process:
- Calculate the average QREs (qualified research expenses) incurred by the company over the last three years.
- Multiply the total average by 50%
- Deduct the value of Step 2 from the current year’s QREs of the company.
- Multiply the outcome of Step 3 by 14 percent to obtain the credit.
- If the business did not incur any research expenses during the preceding three years, the tax savings are equal to 6% of eligible research expenses for the present year.
- Furthermore, several states have their RD tax credits programs. These have their own set of regulations and limitations, so it is a good idea to consult with a tax professional in the particular state your business is located in to determine whether you qualify for both the federal and state credits.
Who is Eligible to Claim the RD Tax Credits?
Any business that accrues expenses while innovating new or significantly improved goods or processes on the US jurisdiction is eligible for the RD tax credits.
A straightforward four-part test can assist you in determining whether your company is eligible for such federal tax credit.
- Dispel any uncertainty. You must have researched to ascertain certainties on the development and enhancement of a product or method. In other words, modifications made merely for aesthetic reasons do not qualify.
- Experimentation procedure. The activities must incorporate some form of experimentation to resolve technical uncertainty (simulation, modeling, trial, and error, or other techniques).
- Of a technological nature. The research must be based on the hard sciences, including biology, chemistry, physics, engineering, and computer science.
- Proper purpose. The activity must have the objective of developing a new or improved product or method that advances functionality, reliability, efficiency, or quality.
Expenses That Qualify for the RD Tax Credits Calculation
Calculating the RD tax credits requires you to document your business’s qualified research expenses (QRE), which include the following:
- Wages paid to individuals directly involved in, managing, or assisting in the development process
- Materials consumed or used throughout the development process
- Contract research expenses are incurred when a third party performs qualifying research on the company’s behalf
- The cost of cloud-based services or leasing machines for research purposes
The study does not have to result in a successful product or procedure for consideration. Even if your initiative or research is unsuccessful, you may still claim the credit.
Special Rules That Apply to Newly Formed or Fledgling Businesses
While the federal RD tax credits is not refundable, you can carry forward your benefit for up to twenty years if your available credit exceeds your tax liability. However, young enterprises with significant research expenses but little or no income tax responsibility have an option that might immediately assist them in decreasing their tax burden.
The PATH or Protecting Americans from Tax Hike Act of 2015 allows new and small enterprises to utilize the RD tax credits toward their payroll tax (FICA) for a period of up to five years. This enables businesses to claim a tax benefit for their research operations regardless of whether they are profitable.
While large firms are not the only ones eligible for the RD tax credits, they are more likely to claim it since they have a legal team and accountants assisting them in navigating the rules.
If you are still unsure whether your business’s research and development activities are eligible for the credit, consider the following questions:
- Did you create anything? You may be qualified for the credit if your company deals with engineering, architecture, construction, manufacturing, software.
- Do you manufacture the same product in the same manner? Your new product or procedure does not have to be novel to the industry; it only needs to be innovative to your business. Businesses rarely manufacture their items same year after year. If your company researches to improve the cleanliness, greenness, speed, or cost of your products or operations, you could be qualified for the tax credit.
If you answered YES to both preceding questions, you might wish to consult an accountant or other tax professional experienced with the RD tax credits.
How A CPA Business or A Tax Expert May Assist You
While the RD tax credits are frequently unclaimed due to ignorance and a lack of knowledge, this does not mean that opting to claim it is an easy task. The RD tax credit is a complicated credit that is project-based, which means that your study must qualify for the benefit. It must then be appropriately and precisely documented. By retaining the services of an experienced tax professional, you can ensure that you are claiming the maximum credit possible and that you do it successfully.