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 California
The state tax credit in California is 15%. However, activities that qualify for the California state tax credit must be conducted in California, and in order to claim the credit, a company must complete FTB 3523.
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. Unused credits can be carried forward indefinitely.
How California’s State Tax Credits Compare to Federal Tax Credits
The California R&D Tax Credit is very similar to the federal version including the definition of qualifying research. Below are some of the differences between the federal and California R&D Tax Credits.
- The credit rate in California is 15% as opposed to the 20% federal credit rate
- There is no Alternative Simplified Credit (ASC) method in California
- California still allows for the Alternative Incremental Research Credit
- Qualified research must take place in California in order to qualify for the California state tax credit
- Unused California research credits can be carried forward indefinitely as opposed to federal credits which can be carried back one year and carried forward twenty
- California has adopted a different definition of gross receipts for companies that provide services
California R&D Tax Credit Case Study
A San Francisco Company develops software used by their clients. It had never before claimed the R&D credit for the development activities of its software programmers. This project involved a four-year study with a three-year look back to claim credits for the years 2017 through 2020.
Based on total Qualified Research Expenditures (QREs) of $3,300,000, the company qualified for the federal R&D Tax Credit of $359,917 and an additional $247,500 in California 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.