If you’re developing new or improving existing technologies in the US, you could recover a portion of your expenditures to offset payroll taxes owing of up to $250,000 per year or to reduce income taxes owing. Not sure if your company can claim that big project your team has been working on? Take a moment to review this 5 point R&D tax credit claim checklist to determine whether you’re eligible and what information you need to have in place so you don’t scramble at deadline on April 15.
1. Is your R&D project eligible?
The R&D efforts must pass a 4-part test in order to be eligible:
- Permitted Purpose: develop new (or improve existing) functionality, performance, reliability, or quality of a business component i.e. any product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.
- Elimination of Uncertainty: discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if publicly available information and knowledge cannot be applied to achieve the desired result i.e. capability of development or improvement, method of development or improvement, or the appropriateness of the business component’s design. Some questions to ask yourself are:
– What uncertainties did you attempt to overcome that could not be removed using standard practice?
– What work did you perform in the tax year to overcome the uncertainties described above?
– What advancements did you achieve as a result of the work described?
- Process of Experimentation: utilize a systematic process to identify the uncertainty as well as identify one or more alternatives to eliminate that uncertainty through, for example, modeling, simulation, or a systematic trial and error methodology.
- Technological in nature: within physical or biological sciences, engineering, or computer science.
Here are some real-world applications that put the R&D tax eligibility criteria into practice.
Created a new product, made improvements or added new features to an existing product?
Modified an existing technology?
Integrated various databases or applications that don’t normally communicate?
Added new features, modified or improved an existing product?
Improved response time of your software application?
Changed a process to reduce costs or to improve manufacturing capabilities/timing?
Incurred costs related to a process, project, or prototype that is incomplete because of unresolved technical problems?
Modified your product formulation?
Modified existing products or machines to new applications?
Machined/fabricated parts/dies using new materials or to meet higher tolerances?
If you answered yes to any of the above questions, you have the potential to claim R&D tax credits.
2. What kind of company are you?
- Startups can apply the credits towards FICA payroll tax liability of $250,000/ year if they are either pre-revenue or they had less than $5 million in gross receipts for the tax year with no gross receipts for more than 5 years from the tax year. For example, if you are claiming R&D tax credits for fiscal year 2016, you should not have gross receipts before 2012 and you should not have more than $5m in gross receipts in 2016.
- Companies with less than $50 million in average revenue for the 3 preceding years can use the credit to offset their Alternative Minimum Taxes (AMT).
- If your company doesn’t fall into those two categories, then you can carry forward the credit to 20 years (or back one year if you had profits).
Bonus: click here to get a free R&D assessment to determine if your company qualifies for a claim and how much you could get back.
3. What have you documented to support your claim?
Start gathering all of your materials as it will help defend your claim in the event of an IRS R&D audit. Can you confirm that your documentation is…
- Contemporaneous? It was documented at the time the R&D was done.
- Dated? It proves that the work occurred in the fiscal year you are claiming.
- Highlights technical challenges? It substantiates the R&D that was done.
What counts as proper documentation?
- Version control for all technical documents
- Prototypes , including software and physical products
- Test documents
- Developer or Engineering Notebooks
- Meeting minutes
- Whiteboard photos
- Invoices/ receipts
- Contractor agreement outlining statement of work
4. When is your fiscal year end?
To offset payroll taxes owing, the R&D tax credits must be specified and elected by a qualified small business with its timely filed (including extensions) return for the taxable year to which the election applies. You can then begin offsetting your social security taxes for the calendar quarter that begins after you file your income tax return with the payroll tax credit election. The IRS provides interim relief for qualified small businesses that timely filed returns for taxable years on or after December 31, 2015, but failed to make the payroll tax credit election. In this case, the business may make the election on an amended return filed on or before December 31, 2017.
C Corps with a December fiscal year end should claim on or before April 15. C Corps with fiscal year ends other than December should claim on or before 4.5 months following the end of the tax year.
S Corps with a December fiscal year should claim on or before March 15. S Corps with fiscal year ends other than December should claim on or before 15th day of the 3rd month following the end of the tax year.
5. Do you have all the forms in order?
The R&D tax claim needs to be submitted with your annual corporate tax filing. Here are all the necessary forms:
- Form 6765, Credit for Increasing Research Activities.
- Form 3800, General Business Credit. This form has a line that asks for the amount of Credit for Increasing Research Activities.
- Each state will have its own form if it offers a state R&D tax program. If you perform R&D activities in California, you will also need to fill out Form 3523, Research Credit.
- If you qualify for the payroll offset described in point 2, you will need to make sure you account for it on Form 941, Employer’s Quarterly Federal Tax Return that is used to pay the employer’s portion of social security tax. You will also need to fill out and attach Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities.
If you’ve never claimed the R&D tax credit before, either because you didn’t think you qualified or you couldn’t use the credits, it’s a great time to reconsider.
If you have any further questions, contact us for a complimentary no-obligation assessment. We will go through your project(s) in more detail, tell you what qualifies and what doesn’t, and provide an estimate of your potential return.
Meanwhile, we’ve summarized everything you need to know about the R&D tax credit program in this easy to understand infographic.