Each year, the US government provides billions of dollars to innovative businesses for developing new or improving existing technologies, products, materials, and processes through the R&D Tax Credit program.
Qualified small businesses and startups can use the R&D tax credits to offset up to $250,000 per year in social security taxes, which typically comes as a refund check from the IRS.
Since every business needs capital for innovation and growth, claiming R&D tax credits is one of the cheapest ways to maximize capital and reduce tax liabilities.
What is R&D Tax Credit?
The R&D Tax Credit program is a general business tax credit under Internal Revenue Code section 41 for companies that incur research and development costs in the United States and has been around since 1981. Under the R&D Tax Credit program, the US government provides billions of dollars every year to innovative businesses for developing new or improving existing technologies, products, materials, and processes.
What Can You Recover with R&D Tax Credits?
The R&D tax credits you can recover can be broken down into two parts – federal and state. The Federal portion is approximately 10% of eligible expenditures that can be used to offset Social Security taxes up to $250,000 per year, income taxes, or alternative minimum tax (AMT). However, the State portion differs from state to state.
R&D Tax Credit in Arizona
The Arizona R&D Tax Credit provides a tax credit for increasing qualifying research activities in the state of Arizona including research funded by taxpayers at state universities.
Arizona has both refundable and nonrefundable credits. The nonrefundable credit was enacted in 1992 and the refundable portion was added in 2010. Arizona leverages off of the federal section 41 rules regarding the calculation and qualification of qualified research activities with some modifications.
- Until December 31, 2030: the state tax credit for corporations is 24% for the first $2.5 million of the sum of qualified research expenses over the base amount and basic research payments, and 15% of the sum of qualified research expenses over the base amount and basic research payments in excess of $2.5 million.
- After December 31, 2030: the state tax credit for corporations is 20% for the first $2.5 million of the sum of qualified research expenses over the base amount and basic research payments, and 11% of the sum of qualified research expenses over the base amount and basic research payments in excess of $2.5 million.
In 2011, Arizona’s non-refundable R&D credit program was also modified into the University Research & Development Tax Credit with the aim to provide additional credit as long as the taxpayer made basic research payments to a university during the tax year. Taxpayers can claim an additional 10% of the basic research payments that are in excess of the base amount for the tax year.
To be eligible for the R&D tax credit, there are strict guidelines and requirements to adhere to. For example, activities that qualify for the tax credit must pass a 4-part test examining the following aspects: Permitted Purpose, Elimination of Uncertainty, Process of Experimentation, and Technological in Nature.
In order to qualify for the Arizona state credit, a company must qualify for the regular tax credit and employ fewer than 150 full-time employees. Unused credits can be carried forward up to 15 years.
Arizona R&D Tax Credit Case Study
A manufacturing company in Phoenix that creates cylinders for the extraction and storage of different coolants and chemicals qualified for a substantial credit. The company claims R&D credits each year for the development activities of its engineers.
Based on total Qualified Research Expenditures (QREs) of $2,550,000, the company qualified for the federal R&D Tax Credit of $233,800 and an additional $306,000 in Arizona state R&D Tax Credit over the 4 years.
Benefits of Claiming R&D Tax Credits
Claiming R&D tax credits has many attractive benefits. Firstly, the R&D tax credits can be used to offset the employer portion of your Social Security taxes up to $250,000 for each fiscal year.
The Social Security tax offset allows qualified small businesses to receive a benefit for their research activities regardless of profitability. R&D tax credits can also be used to offset income taxes if you are in a taxable position, which is dependent on your previous tax return statements.
In addition, the R&D tax credits can be used to offset the AMT if you have less than $50 million in average revenue for the 3 preceding years from the tax year, and you owe AMT in the current year.
Preparing Documentation for R&D Tax Credit
Although the R&D Tax Credit program can potentially help your business recover large amounts of your research and development spend, claiming the tax credits is a complicated process.
There are multiple forms and documentation that you will need. Additionally, documentation also has to adhere to strict criteria, such as:
- It has to be contemporaneous which means it has to be documented at the time the R&D was done. The bigger the claim, the more documentation you would want to have.
- Your documentation must also be dated. You need to prove that the work occurred in the fiscal year you are claiming.
- Your claim needs to highlight technical challenges such that it substantiates the R&D that was done.
Work with Boast.AI for your R&D Tax Credits
Given the complicated process of claiming tax credits, consider working with our Boast.AI team. Boast.AI helps innovative businesses automate the complicated process of claiming R&D incentives. By combining AI-driven software with in-house R&D tax experts, we can help your company get larger returns without the grunt work and audit risk.
With engineers and finance professionals armed with over 20 years of experience in this field, our team has extensive knowledge about the R&D Tax Credit program. We will stay engaged throughout the year to help you identify R&D eligible work on an ongoing basis, enabling us to provide information on other technology grants and financing opportunities.
Moreover, in the event of an R&D review by the IRS, we will defend you in the process and help to ensure that your claim is successful. Get in touch with us now to request a free assessment and get started on your next R&D claim.