The Research and Development (R&D) tax credit is a government-sponsored program that encourages businesses to invest in innovation and improve their competitiveness. The program provides tax relief for companies that incur expenses on R&D activities.
These tax instruments had minimal changes from their introduction in 2000 until recently, in 2021, when the government announced some proposed changes that were seen as an effort to support modern research needs by expanding qualifying expenditures such as data and cloud costs.
As a proactive accountant or tax planner, it is important to provide tax-saving opportunities that your clients may not know about.
And the R&D tax credit is one of those opportunities that up to 90% of small businesses and startups fail to utilize. Therefore, familiarizing yourself with this tax credit and its benefits is essential if you truly want to deliver value to your clients.
Here is a quick overview of what you need to know about the R&D tax credit:
The R&D tax credit is a dollar-for-dollar reduction of a company's tax liability that can be used to offset income tax liability, payroll tax liability, or alternative minimum tax liability.
The R&D tax credit can be claimed by companies of all sizes that incur eligible expenses on R&D activities. Unlike other tax incentives, the R&D tax credit does not require the company to be profitable or to have generated any revenue. This makes it a great option for early-stage startups and small businesses.
This credit spreads across many industries, including technology, manufacturing, architecture and engineering, and even medical and scientific research. As long as the company is engaged in new activity, it may be eligible for the credit.
According to the IRS, for an activity to qualify as an R&D, it must:
Qualifying research expenses (QREs) are those incurred in experimental or laboratory situations. This includes W-2 employee wages, contract research expenses, and certain supplies used in the research process. These expenses must be incurred in the United States in order for the company to claim the credit.
R&D for internal software has three more criteria to meet:
Activities that may be considered for the R&D tax credit include:
And really, the research doesn't have to be related to a new product or novel service. Even improving an existing product or process can qualify. Fortunately, even if the research is unsuccessful, the company can still claim a tax credit for its expenses.
There are specific types of research activities that are excluded from receiving R&D credit, including:
The R&D tax credit can be claimed on a company's federal income tax return. The credit is claimed as general business credit, which can offset both regular and alternative minimum tax (AMT) liability. Any unused credit can be carried forward for up to 20 years.
To claim the credit, the company needs to file IRS Form 6765 with its tax return. The form must include a description of the qualified research activities and the expenses incurred.
The IRS now wants more documentation to support R&D claims. While not officially approved, a proactive accountant must be prepared to provide the following:
To calculate the credit, the company will need to determine its qualified research expenses (QREs) for the year, such as W-2 employee wages, contract research expenses, certain supplies used in the research process, and qualifying contractor research expenses. These expenses must be incurred in the United States in order for the company to claim the credit.
Here's what you'll need to know about your client's QREs:
The federal R&D credit allows for an Alternative Simplified Credit (ASC), which is easier to calculate. It only uses the prior three years of historical R&D expenses.
Savvy accountants can combine workflow solutions with software such as RetroacDev and TaxPlanIQ to streamline their clients' R&D tax credit filing process and make it super easy to generate file Form 6765.
To calculate ASC:
ASC = (Current years QREs - (Avg QREs for the past 3 years X 50%))X14%
If the client has no QREs within the 3 years preceding the tax year, the ASC rate is 6% of the QREs for the credit determination year
Technology can help you streamline your clients' R&D tax credit filing process, making it super easy to generate file Form 6765.
Software solutions such as RetroacDev and TaxPlanIQ can help automate repetitive tasks, saving you time and money. These solutions can also help you manage multiple clients more efficiently by providing a centralized platform to track deadlines, manage workflows, and generate reports.
In particular, TaxPlanIQ has a comprehensive R&D strategy template that allows you to customize and optimize the credit by running multiple "what if" scenarios. This is a great way to help your clients maximize their R&D tax credit.
Sample 1
Client 1 is a tech startup.
Sample 2 (using software such as RetroacDev and TaxPlanIQ)
Client 2 is a tech startup.
As you can see, the idea is to offer faster, more competitive services by leveraging technology. This is a great way to differentiate your firm and attract new clients.
The R&D tax credit is a great way for companies to offset the costs of their research and development activities. However, it's important to understand the rules and regulations around credit to maximize your clients' value.
If you want to stay ahead of the curve, deliver more value to your clients, and become indispensable, leverage technology to make the R&D tax credit filing process as seamless and painless as possible. Utilizing solutions such as TaxPlanIQ and RetroacDev can help streamline the R&D tax credit filing process, saving you time and money.
These solutions can also help you manage multiple clients more efficiently by providing a centralized platform to track deadlines, manage workflows, and generate comprehensive reports that will help you optimize the credit for your clients. And what's better, RetroacDev offers 15% off for TaxPlanIQ clients, allowing you to deliver more value at a fraction of the cost.