R&D Tax Credits

Everything You Need to Know About the US Research & Development (R&D) Tax Credits.

What are R&D Tax Credits?

The R&D tax credit is a U.S. federal government incentive that allows companies to receive a tax credit for eligible expenses related to research and development (R&D) activities.

The tax credit encourages businesses of all sizes, from large enterprises to small businesses, to invest in R&D, resulting in new products, improving existing products, services, processes, and procedures, or creating prototypes.

R&D tax credits are important for businesses to provide significant relief on the costs associated with R&D activities. This can free up funds that can be reinvested into the business or reduce the taxable income.

The R&D tax credit can also encourage businesses to undertake more R&D activities, claiming a proportion of their expenditure back and offset payroll taxes. This can lead to greater innovation and improved products and services for consumers and give eligible small businesses and startup companies a chance to maximize federal credit.

Located in Canada? Learn about the SR&ED.

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R&D Tax Credit Eligibility

Who can submit an R&D Tax Credit claim?

Businesses of any size or sector can submit an R&D tax credit claim, provided they are conducting qualifying R&D activities. The research conducted must aim to advance overall knowledge or capability in a field of science or technology.

Companies that incur costs during the financial year for R&D can submit an R&D tax credit claim. This includes companies who are registered for VAT or PAYE.

Eligible Industries

R&D tax credits are available to companies in a broad range of industries. To qualify, your company must be engaged in activities that involve the development or improvement of an existing product, process, technique, formula, invention, or software.
Common eligible industries for the R&D tax credit include:

Is My Project Eligible for R&D Tax Credits?

A few general guidelines can help you determine if your business might be eligible for tax incentives.

  1. Your business must engage in qualified research activities as defined by the IRS
  2. Your business must have incurred eligible research expenses in the current or previous tax years
  3. Your business must be located in the United States

If your business meets these criteria, you will likely be able to take advantage of the R&D tax credits.

Generally, qualifying activities must meet all of the following requirements:

  • New or improved products, processes, or software
  • Technological in nature
  • Experimentation or analysis

If your company is engaged in any of the above activities, you may also be able to take advantage of the tax incentives.

R&D Tax Credit Expenditures Qualification

Which items qualify as expenditure?

The R&D tax credit is meant to encourage companies to undertake innovative R&D activities. To qualify, your firm’s expenses must be for operations that are:

  1. Conducted to discover information that is technological in nature
  2. Intended to create or improve a business process or product
  3. Carried out through a systematic trial and error process

Also, your company must have incurred qualifying expenditures related to:

  1. Experimental or laboratory testing
  2. Design, engineering, and prototyping activities
  3. Software development
  4. Process or product improvement activities
  5. New product or service development

How is the R&D Tax Credit Calculated?

To calculate the R&D tax credit, you must first determine your eligible R&D expenses. Eligible expenses include wages paid to employees who are directly engaged in R&D activities, costs of supplies used in R&D activities, and contract research expenses.

Once you have determined your eligible expenses, you can calculate your credit by multiplying those expenses by the applicable credit rate.

The applicable credit rate is 6% for small businesses and 14% for large businesses. For example, if a small business has $100,000 in eligible R&D expenses, its credit would be $6,000 (100,000 x 0.06). If a large business has $1 million in eligible R&D expenses, their credit would be $140,000 (1,000,000 x 0.14).

The R&D tax credit can be claimed as a dollar-for-dollar reduction of your business’ income tax liability. If your company has no income tax liability, you may be able to carry the credit forward to offset taxes in future years.

Alternatively, some states offer refunds for businesses that claim the R&D tax credit.

CTA: Estimate your potential return with the R&D Tax Credit Calculator

R&D Tax Credit Claim Process

The R&D tax credit claim process can be quite complex, but some key steps can make it easier.

R&D Credit Claim Fundamentals

Here are a few tips to help you get started:

  1. Know what expenses qualify for the credit. Only costs associated with qualified research expenses and activities are eligible for the credit. These include wages paid to employees working on research projects, payroll records and taxes, supplies and equipment used in research, and contract research expenses.
  2. Keep good records. Be sure to keep track of all expenses related to your research activities to easily document them when it comes time to file your claim. This includes gross receipts, time-keeping documentation, and salaries.
  3. Gather supporting documentation. In addition to recording your expenses, you’ll need to provide supporting documentation to show that your research activities meet the criteria for the R&D credit. This can include project proposals, lab notebooks, publication records, credible employee testimony, and cash flow.
  4. File your claim form. The actual process of filing a claim for the R&D tax credit will vary depending on which jurisdiction you’re claiming in (federal, state, or local). But in general, you’ll need to complete a claim form and submit it along with your supporting documentation.
  5. Stay compliant. Keep up with the latest rules and regulations regarding the R&D tax credit, as they can change yearly. This will help ensure that your claim is accepted and that your company’s tax liability is updated.

When to submit your claim?

There is no deadline to submit your R&D tax credit claim. However, it is important to note that the credit can only be applied to qualified research expenditures incurred in the current or previous tax year. Therefore, you should submit your claim as soon as possible after incurring eligible expenses.

You can claim the R&D tax credit against your income taxes or payroll tax liability. If you are claiming the credit against your federal income tax liability, you may be able to carry the credit forward or backward to offset taxes owed in other years.

Preparation for Your R&D Claim

Preparing for a first R&D claim

Suppose you consider claiming the R&D tax credit for your qualified small business. In that case, it is important to seek R&D tax experts such as Boast to ensure that you meet all of the eligibility requirements and understand how to file a claim properly.

A qualified tax professional can help you maximize your credit and minimize your state tax liability.

Tools to use to help simplify your R&D claim

There are tools to help simplify your R&D tax credit claim. These are:

  • R&D Tax Credit Estimator: This tool from the IRS can help you estimate the amount of credit you may be eligible for
  • R&D Tax Credit Calculator: Boast online calculator can help you determine the amount of credit you may be eligible for based on your qualifying expenses
  • R&D Tax Credit Worksheet: This worksheet from the IRS can help you determine the amount of credit you may be eligible for and calculate your credit

Time Tracking Best Practices

There are a few key best practices to keep in mind when tracking your time for R&D tax credit purposes:

  1. Make sure to track your time as accurately as possible. This means recording each task’s start and end times and any breaks taken during the day
  2. Be sure to include detailed descriptions of the work completed during each period. This will help to ensure that your records are complete and accurate
  3. Keep all of your documentation in one place to make it easily accessible when needed

By following these simple tips, you can ensure that you can take advantage of the full benefits of the R&D tax credit.

During the Claim

Understand the R&D Tax Credit Forms

Form 6765 is used to calculate the credit amount that can be claimed on qualified research expenses. This form must be completed in order to claim the credit on your taxes. The form must be filed with the taxpayer’s annual income tax return.

Form 6765 consists of five parts:

  • Part I – Figuring the Credit
    • This is used to calculate the amount of the credit that the taxpayer is eligible for. This part of the form must be completed even if the taxpayer is not claiming the credit in that tax year.
  • Part II – Qualified Research Activities and Expenditures
    • Allows taxpayers to itemize their qualified research expenditures to be taken into account when calculating the credit.
  • Part III – Certification Regarding Eligibility to Claim the Credit
    • Requires taxpayers to certify that they are eligible to claim the credit.
  • Part IV – Consent to Disclosure of Information
    • Allows taxpayers to give the IRS consent to disclose information about their tax return to third parties, such as their accountant or lawyer.
  • Part V – Signature
    • Requires the taxpayer’s signature.

Technical Documentation

To support your claim, you will need to provide:

  1. A detailed description of the project or activity undertaken. Include a description of the business, its products and services, and how the R&D activities help achieve its goals. Describe the R&D activities in detail, including how they are conducted and what they aim to achieve.
  2. The total eligible costs incurred. Outline the costs associated with the research and development activities, including any investment in equipment or other resources. Provide evidence to support your claim for the R&D tax credit, such as detailed records of expenditure on R&D activities.
  3. Supporting documentation such as invoices, contracts, timesheets, or payroll taxes records. Identify the staff involved in the R&D activities and their roles within the company.

Business plan or other evidence to show that your company is planning to engage in further R&D activities. This usually applies to first-time claimants.

After the Claim

Prepare for an Audit

If your R&D tax credit claim is selected for an audit by the IRS, don’t panic. An audit means that the IRS wants to review your records to verify the information you reported on your return.

Audits are rare for the IRS but more common for the CRA.

There are a few things you can do to prepare for an audit:

  1. Gather all of the documentation supporting your claim. This includes average gross receipts, invoices, contracts, and other business component records such as payroll taxes, payroll tax credit records, and basic research payments that show how much you spent on R&D activities.
  2. Organize your documents in a way that makes sense. The IRS auditor will want to see how you arrived at the figures you reported on your return, so it’s important to have a clear and concise paper trail.
  3. Be prepared to explain your R&D activities in detail. The auditor will want to know what you were trying to accomplish with your research and how your expenses relate to those objectives.

Hire an R&D tax consultant to help you throughout the audit process. An experienced tax advisor can answer the auditor’s questions and help you put your best foot forward.

Improve Your Claim Process for Next Year

Here are some ideas for the following year to keep your company’s paperwork and data organized for next year:

  1. Track your records and document them well. Keeping good records is one of the most crucial steps you can take to guarantee a successful R&D tax credit application. All examples are keeping track of your project expenses, documenting your research activities, and maintaining detailed logs or diaries.
  2. Prepare a plan. Another way to improve your R&D process is to prepare a plan. This implies determining which business components or projects are eligible for the tax incentives and ensuring that you have all the necessary documentation.

Automate your tax credit process. Boast has data vendor integrations to ensure that your documentation is automated and secure.

Automating Your R&D Tax Credit Claim Process

If you’re claiming the credit for the first time, the process can be time-consuming. There are a lot of forms to fill out, and you need to make sure that you have all of your supporting documentation in order.

There are a few things that you can do to make the process easier. You can use Boast’s R&D tax credit software to automate the tax credit claim process. This will help you:

  1. Keep track of your expenses and make sure that you include all of the necessary documentation.
  2. Keep your documentation organized. This will make it easier to submit your claim and provide the IRS with the information they need if you’re selected for an audit.
  3. Keep good records of your expenses. This includes gross receipts, invoices, and any other supporting documentation. The IRS may request this information if you’re audited, so it’s important to have it readily available.

Software designed specifically for the R&D tax credit, such as Boast, can automate many of the tasks involved in preparing a claim. This includes automatically tracking eligible expenses, calculating rates, and completing forms.

R&D Tax Credit Examples

Security

The efforts for protecting data and defending businesses from cyber-attacks are becoming costly. If your company is involved in this kind of work, you might be eligible for a Security R&D tax credit.

The tax credit provides incentives that can help reduce the costs of investing in security R&D. This involved designing and developing new security products and procedures, improving existing ones, and researching ways to improve security technology.

To qualify, the following criteria must be met:

  1. The technology must be for the purpose of information security;
  2. The technology must be new or improved;
  3. The technology must be created to meet a business need.

Eligible companies can receive a tax credit of up to 20% of their qualifying R&D expenses. This includes salaries, materials, and other eligible costs.

The goal of R&D security tax credits is to assist firms in developing security-related technologies and tools. These discoveries might help secure our networks against attacks and provide new methods for managing or eliminating risks.

Software & Gaming

The software and gaming development tax credit can be used to offset costs associated with developing new or improved software products. The R&D tax credit can be used to reduce costs associated with developing or improving software, such as:

  • Designing new or enhanced algorithms
  • Developing prototypes
  • Conducting feasibility studies
  • Performing engineering analysis
  • Creating or modifying source code
  • Systems integration testing

However, the IRS released new software R&D credits rules. Software and gaming development projects will be classified as high-risk, moderate-risk, or low-risk. The higher the risk, the higher the chance of not being qualified.

The primary objective of software research and development should be to eliminate software development uncertainties. The IRS will evaluate the planned R&D projects from most dangerous to least dangerous in order to speed up the audit process.

In addition, the IRS is paying more attention to the software development activities that companies are saying should be considered research under the Research Credit.

If you’re not sure whether the software development activities are qualifying research or if you’ve never claimed R&D tax credits, Boast may be able to help.

Robotics

The Robotics R&D tax credit was created to incentivize businesses to invest in innovation for the robotics industry. The credit can be used to reduce the cost of new equipment, software, and employee training. The credit is capped at $250,000 per year and can be applied against the cost of qualified R&D expenses incurred in the United States.

To be eligible for the credit, businesses must have a robotic system integrated into their manufacturing process or use robots to perform tasks that are considered hazardous or difficult for humans to perform. Additionally, businesses must demonstrate how robotics has increased productivity, efficiency, and safety.

The benefits of the robotics R&D tax credit include:

  1. Increased productivity: Robotics can help businesses increase output while reducing production costs. When robots are used in manufacturing, they can work faster and more accurately than humans, increasing efficiency and productivity.
  2. Improved safety: Robots can perform tasks that are considered hazardous or difficult for humans to conduct, such as working in high-risk environments or handling dangerous materials. This can help improve worker safety by reducing the need for human employees to be exposed to potential risks.

Enhanced competitiveness: The use of robotics can give businesses a competitive edge by helping them reduce production costs and improve quality control. Additionally, the adoption of robotics technology can help companies to keep up with the latest trends and advances in the manufacturing industry.

Finance

The government’s R&D tax credits scheme is a great way for companies in the finance sector to get money back on their investment in research and development. The credit is worth up to 25% of eligible R&D expenditure. It can be used to offset corporation tax based on the internal revenue code.

However, companies that engage in research activities throughout the year may save on R&D tax benefits and build an asset that can’t be used until taxes are filed, and the R&D refund is received.

This entire process, which may take up to 9 months after the fiscal year, slows down how quickly businesses can reinvest their gains back into the company. The disadvantage is that firms must wait 12-16 months to reallocate their R&D refund into corporate development.

Instead, companies with credit-worthy backgrounds and qualifying R&D expenses can apply for financing. Companies can reinvest their gains back into the company more quickly. The process is shorter and simpler than traditional bank financing.

There is no need for a business plan or other extensive documentation. Qualifying companies can receive up to 80% of their total R&D tax credit in cash, with the remaining 20% paid out when the government issues the tax credit refund.

To be eligible, a company must have been conducting qualifying activities for at least six months and doing so lawfully. To determine whether you’re qualified, contact a financial professional that specializes in R&D financing, such as Boast.

R&D Tax Credit Consultant

Why choose a R&D Tax Credit Consultant?

Some benefits come with having a consultant to help you take advantage of the R&D credit.

  1. An R&D Tax Credit Consultant Can Help You Save Time
    • One of the biggest benefits of working with a consultant is that they can save you time. Applying for the R&D tax credit can be complex and time-consuming, so it’s helpful to have someone on your side who knows the ins and outs and can guide you through the process quickly and efficiently.
  2. An R&D Tax Credit Consultant Can Help You Save Money
    • Another big benefit of working with a consultant is that they can help you save money. The R&D tax credit can be worth a significant amount of money for your business. A consultant can maximize your savings by taking advantage of all the available research and development tax credits.
  3. An R&D Tax Credit Consultant Can Help You Stay Compliant
    • It’s important to note that the R&D tax credit is a government-sponsored program, which means businesses must follow strict rules and regulations to qualify. A consultant can have management functions to help you navigate the complex compliance landscape and ensure that your business meets all the requirements, even for prior tax years.
  4. An R&D Tax Credit Consultant Can Help You Maximize Your Savings
    • Finally, a consultant can help you maximize your savings by taking advantage of all the available research and development tax credit and deductions. The R&D tax credit is a complex program with many different rules and regulations, so it’s helpful to have someone on your side who knows how to maximize your savings.

Boast has worked with a venture company that received the single largest return of dollars. Boast assisted in quantifying eligibility and getting the highest possible returns from the R&D tax credit program. With Boast’s AI-based R&D tax credit software platform and experts, it could speed up identifying qualifying projects and submitting complete documentation.

If you’re a qualified small business thinking about taking advantage of the R&D tax credit, working with a consultant like Boast is a great way to get the most out of the program.

Frequently Asked Questions

A:Net operating loss (NOL) is a term used in the United States tax code to refer to a business or individual with more deductions than income in a given tax year. When this occurs, the company or individual is said to have an “NOL” for that year. An NOL can be created by several things, including business expenses, personal losses, and charitable contributions. Once an NOL is created, it can be used to offset taxes owed in future years. This can be helpful for businesses and individuals who have sporadic income or who experience losses in some years but not others. There are some restrictions on how an NOL can be used. For example, an NOL can only be used to offset taxes owed in future years, not taxes owed for the year in which the NOL was created. Additionally, an NOL can only be used to offset a certain amount of taxes owed; any excess NOL will generally be carried forward to future years.
A:The biggest difference between the R&D tax credit and an NOL is that the R&D tax credit can be used to offset taxes owed in the current year, while an NOL can only be used to offset taxes owed in future years. Additionally, the R&D tax credit can be used to offset a wide variety of taxes, including income taxes, payroll taxes, and even some excise taxes. By contrast, an NOL can generally only be used to offset income taxes. Another key difference is that there are no restrictions on how the R&D tax credit can be used; businesses and individuals can use it however they see fit. This flexibility makes the R&D tax credit an attractive option for companies and individuals looking to reduce their tax liability. When it comes to choosing between the R&D tax credit and an NOL, it depends on your unique situation. If you have an NOL for a given year, speak with a tax professional to see if it makes sense to use it to offset taxes owed in future years. On the other hand, if you’re looking for a way to reduce your tax liability in the current year, the R&D tax credit may be a better option. Unlike NOLs, which are recorded on the balance sheet as deferred tax assets, R&D tax credits are not accounted for in the company’s financial statements. Because they are accounted for in the financial statements differently than they should be, this often causes perplexity over their true value. Whether they’re recorded as an asset on the balance sheet, they’re still a key asset to any business that might provide substantial value in company valuations and M&A deals. The timing of a company strategy shift to a profitable position is unknown, but the fact remains that accumulated R&D tax credits will benefit all discounted cash flow calculations. Even if you are not presently utilizing the credits, if you apply a discounted cash flow analysis to your company valuations, the tax credit offsets will raise your valuation as your business grows in future years.
A:A major benefit of tax credits for research and development is the ability of federal and other state governments to cut the federal income from the tax bill. The company will receive a dollar-for-dollar tax credit while deducting costs for research and development, which could reach 10 to 15 percent of its annual return. The tax credit can help startup companies and small businesses offset some of their payroll tax liability. Also, it can be used to offset the Alternative Minimum Tax for qualified small businesses.
A:If federal research and development credit cannot be used immediately, the refunded credit can be carried back one year or for 20 tax years. The value of your tax credits accumulates over time and can be carried forward for 20 years. So even if you can’t use your tax credits in the current fiscal year, they still accumulate and can provide tremendous value to your company.
A:R&D credit carryovers happen when non-refundable credits are repaid in a subsequent tax year. The money you cannot spend on your current tax return is used on your next tax return. It applies dollar-for-dollar reduction to future cash tax liability reduction.
A:These adjustments and lists are based on the IRS’s Audit Guidelines on the application for the software R&D tax credit program. - Maintaining and configuring existing software applications. - Reverse engineering. - Performing studies, or similar activities, to select vendor products. - Detecting flaws and bugs in the software application. - Modifying an existing software business component to make use of new or existing standards or devices, or to be compliant with another vendor’s product or platform - Developing a business component that is substantially similar in technology, functionality, and features to the capabilities already in existence at other companies. - Upgrading to newer versions of hardware or software, or installing vendor fix releases - Re-hosting or porting an application to a new hardware or software platform, or rewriting an existing application in a new language. - Writing hardware device drivers to support new hardware. (e.g., disks, scanners, printers, modems, etc.) - Data quality, data cleansing, and data consistency activities. - Bundling existing individual software products into product “suites.” - Expanding product lines by purchasing other products. - Interface software development activities. - Y2K program changes. - Vendor product extensions. - Graphical User Interfaces (“GUI”)
A:These adjustments and lists are based on the IIS’s Audit Guidelines on the application for the software R&D tax credit program. - Functional enhancements to existing software applications/products. - Software developed as embedded applications. - Development of software utility programs. (e.g., debuggers, backup systems, etc.) - Changing from a product based on one technology to a product based on a different or newer technology. - Adapting and commercializing technology developed by a joint association or an open software group.
A:These adjustments and lists are based on the IRC’s Audit Guidelines on the application for the software R&D tax credit program. - Requiring new constructs (e.g., new architectures, algorithms, etc.) for the initial release of an application software product. - Developing system software (e.g., operating system) may include resolving uncertainties related to process scheduling and memory management designs, and instruction execution optimization. - Developing specialized technologies. (e.g., AI, speech recognition, etc.) - Developing software as part of a hardware product wherein the software interacts directly with that hardware to make the hardware/software package function as a unit.
A:For any kind of research, there may be a research credit available under the tax code, and that could impact income tax for the company. Some credits come in the form of a payroll tax credit to offset corporate tax hikes according to the internal revenue code.