Ever since it was adopted in 1981, the R&D (formerly known as the Research & Experimentation) Tax Credit has been one of the most meaningful resources used by companies, across different industries, to improve their bottom line. This tax incentive was initially designed to encourage domestic innovation and R&D investment, but it has constantly evolved during its lifetime. According to research, around 17,700 public and private companies have claimed this tax incentive totaling $6.6 billion dollars. Most eligible companies (more than 65%) have overlooked or failed to take advantage of this very great opportunity. If you are considering on applying for an R&D tax credit, you might want to look into availing the services of an R&D Tax Credit Software provider.
What is the R&D Tax Credit?
The R&D tax credit was designed to provide U.S. companies a tax incentive encouraging them to increase spending on research and development in the U.S. If a company’s activities meet the requirements for the R&D tax credit, there are two ways to calculate it:
- Traditional Method –under this method, the credit is 20% of the company’s current year qualified research expenses on top of a base amount.
Calculating the base amount can be quite complicated. It’s the result of a fixed-base percentage and the company’s average annual gross receipts for the previous four tax years.
Companies that were unable to claim the R&D credit in the past or those that didn’t have the necessary data to determine their historical qualified research expenses are more likely to find it easier to calculate their credit using the second method.
- Alternative Simplified Credit Method –there is a four-step process involved in this method and they are:
- To determine the company’s average qualified research expenses (QREs) for the past three years.
- To multiply that average by 50%
- To subtract the result in step 2 from the company’s current year QREs and
- To multiply the result in step 3 by 14% in order to calculate the credit
If the company didn’t have any research expenses in the last three years, the tax savings is 6% of the current year’s qualified research expenses.
Many states also have their own R&D tax credit programs. These come with their own rules and limits, so it would be wise to consult with a professional in your state to determine whether you can benefit from both federal and state credit.
R&D Tax Credit Benefits
The R&D tax credit is one of the most profitable incentives under the current U.S. tax law. This is because compared to standard deduction, it is a dollar-for-dollar credit against your tax liability. Based on factors such as your company’s qualified research expenses, the credit can include eligible wages, supplies, and outside contractor expenses. In addition, this tax incentive is offered in more than 30 states. Lastly, the R&D tax incentive is available for all open tax returns, including up to three prior years and the current tax year. In case of inadequate tax liability, companies can carry the credit forward to 20 years.
How Do You Qualify?
One common misunderstanding with regards to the Research and Development (R&D) tax credit is that it is exclusively for lab-coat activities and manufacturers. However, new laws have expanded the industries and companies that qualify for the credit. Below are some of the most common R&D eligible activities:
- Prototyping and patent applications
- Pre-production design and engineering of a new product or improving an existing product
- New process or improvements on production
- Software development for sale or internal use
- General trial and error experimentation
- Experimenting or trying out new concepts, materials, tools, formulations, and processes
This is a summary of the Four-Part Test criteria for Qualified Research Expenses:
- Elimination of Uncertainty –the activity must be done to eliminate uncertainty regarding the capability or method of developing or improving a product or process. It can also involve determining the appropriateness of the product design.
- Process of Experimentation –this process is designed to evaluate one or more options to achieve a result wherein the capability or method used to achieve the result, or the relevant design of that result, is uncertain as the start of the taxpayers’ research activities.
- Permitted Purpose –the activity must be related to a new or improved business component’s performance, quality, function, composition, and reliability. It’s not necessary to discover something new to your industry, only that is innovative or new to your company’s products or processes.
- Technological in Nature –the activity done must rely on the basic principles of physical sciences, computer science, engineering, or biological sciences. For instance, if your business involves food production, simply adding more salt to your product doesn’t necessarily qualify you for the credit. However, a method using hard sciences to improve your product’s flavor would.
R&D Tax Credit Software
If you need help in filing for an R&D tax credit, you can seek help from professionals, or you could use an R&D tax credit software. There are companies that provide top notch engineering analysis to help business owners maximize the credit under the law. They have software that help streamline the way to capture the R&D credit as accurately and in the most IRS-defensible way possible. Check out GOAT.tax software platform.
GOAT.tax software platform is well-versed where R&D tax credit is involved. With more than 9,800 tax credit studies filed, it’s safe to say they know their way around this matter. They’ll provide you with all the assistance you need so you spend less time filing returns and focus more on things that matter for your business.
GOAT.Tax’s R&D tax credit software makes it easy for business owners and key innovators to track their R&D activities as they go. This software was developed to help companies get the tax credit they rightly deserve. With their years of experience across their nationwide team of 50+ R&D tax professionals, you can be sure that they can take all the guesswork from this complicated tax incentive. In short, they’ve got you covered!