Research and Development Tax Credit Resource Center
Many businesses could save money on their taxes by claiming the Research and Development (R&D) tax credit. However, many business owners don't claim the credit because they don't realize that they qualify or because they don't know how to calculate the amount of the credit.
This guide is designed to help businesses understand what the R&D tax credit is, how it works, and how to claim it.
Even though the R&D tax credit can be complex, this guide will walk businesses through the process step-by-step.
What is the Research & Development Tax Credit?
The R&D tax credit is a government program that gives businesses a tax break for investing in research and development. This incentive encourages businesses to create new products, processes, and software that can benefit the economy.
The R&D tax credit can be used to reduce the amount of tax owed or increase a tax refund.
To qualify for the R&D tax credit, businesses must incur eligible expenses on specific types of research, known as qualified research activities. There are two ways to calculate the R&D tax credit:
Simplified method: This method is simpler to calculate, but it may not result in the highest possible credit.
Regular method: This method is more complex to calculate, but it may result in a higher credit.
Ways To Calculate R&D Tax Credit
The traditional method of calculating the R&D tax credit is more complex than the simplified method. It involves calculating a base amount, which is based on the company's average annual gross receipts for the prior four tax years. The credit is then calculated as 20% of the company's qualified research expenses (QREs) that exceed the base amount.
Some companies find the traditional method unreliable and cumbersome because it relies on a base period of expenses and gross receipts. Additionally, the base amount can never be less than 50% of QREs for the current year. This can result in a lower credit for companies with high QREs.
Alternative Simplified Credit (ASC) method
The ASC method is a simpler way to calculate the R&D tax credit. It involves a four-step process:
Calculate the company's average QREs for the past three years.
Multiply the average by 50%.
Deduct the result from the company's current year QREs.
Multiply the result by 14%.
If the company had no research expenses in any of the prior three years, the credit is 6% of QREs for the current year.
Many companies find the ASC method to be a less burdensome methodology to calculate the credit. It is simpler to understand and implement, and it is less likely to result in a lower credit than the traditional method.
Which method is right for you?
If you have a history of claiming the R&D tax credit and you have the necessary data to calculate your base amount, you may want to use the traditional method. However, if you are new to the R&D tax credit or you do not have the necessary data, the ASC method is a simpler and more straightforward option.
Who can claim the R&D tax credit?
Many businesses don't claim the R&D tax credit because they think it's too difficult to do. However, the credit is available to any business that spends money on developing new or improved products or processes.
With the right documentation, you can determine if your business qualifies for the credit. Useful records include:
Tax and payroll records
Testing documentation, such as project records, lab notes, and prototypes
Reports that track time, expenses, and other project accounting data
It's important to establish a documentation process as soon as possible. If you wait until tax filing season to start gathering your records, you may have difficulty finding all of the information you need.
What Activities Are Excluded?
The tax code does not allow all research activities to be claimed for the R&D tax credit. According to the IRS instructions for Form 6765, the following activities are excluded:
Research that is performed after the product or process has already been commercially produced
Research that is simply adjusting an existing product or process to meet the needs of a specific customer
Copying an existing product or process
Surveys and studies
Research on certain types of internal-use computer software
Research in the social sciences, humanities, or arts
Research that is financed by someone else, such as another company or a government agency
What expenses can be used to calculate the R&D credit?
To calculate the R&D tax credit, you need to document your company's "qualified research expenses" (QREs). QREs are expenses that are incurred in the process of developing new or improved products or processes.
The three main types of eligible QREs are:
Salaries paid to employees who are directly working on or supporting the development process
Supplies used in the development process, such as materials and computer rentals
Contracted research expenses paid to third parties to perform qualified research activities
What is Processing Time for R&D tax credits?
You must claim the R&D tax credit within two years of the tax year in which the research was conducted. If you miss the deadline, you may be able to file an amended tax return to claim the credit.
It typically takes 4-6 weeks for the IRS to process an R&D tax credit claim. Once the claim is processed, it may take another week for the IRS to transfer the money to your account.