“The avoidance of taxes is the only intellectual pursuit that carries any reward.” John Maynard Keynes
Q: Who qualifies for the R&D Tax Credit?
A: One of the common misconceptions about the R&D Credit is that it is reserved for companies with teams of scientists in lab coats. In reality, any company working to solve a particular technical problem through trial and error can claim expenses associated with that problem solving towards the credit. This can range from developing new software to providing engineering services needed to deliver a technical solution for a client. If your company evaluates alternatives and uses principals that are technical in nature (i.e., engineering, computer science, or physical sciences) to solve any type of problem then the R&D Credit is for you.
Q: Can a small business still benefit from the credit?
A: Yes. The 2015 PATH Act opened up the R&D credit for small businesses that have little to no taxable income. A qualified small business can now use the credit to offset up to $250,000 in payroll tax burden and are also able to offset AMT. Qualified small businesses are defined as entities with less than $5 million in gross receipts and no gross receipts in the tax year 5 years prior to the year in which the credit is being claimed. This opens up the R&D Credit for immediate use by start-ups who traditionally could not use tax credits right away.
In general, the R&D credit encourages companies to capture tax credits when qualified research has been performed. In addition to the rules for small businesses, the credit can be carried forward for 20 years. Therefore, if a company is performing qualified research activities but does not see a direct need for tax credits, it can bank credits for future use in offsetting tax liability.
Q: How do I claim the R&D Credit?
A: A taxpayer can claim the R&D Credit by completing Form 6765. In order to complete this form, a company must identify qualified research expenses (QREs) as defined by section 41(d) of the Internal Revenue Code. QREs are connected to qualified research activities. While there is a wide array of treasury guidance and tax court rulings that govern what is to be considered qualified research, in general, any wages, subcontractors, or supply expenses associated with the trial and error process used to solve technical problems can be counted. For software companies, any cloud expenses associated with development, testing, or “sandbox” server space can also be claimed. Identifying qualified research expenses usually requires guidance from third-parties with expertise in the various tax law surrounding the credit.
Q: How long can I use the credit for?
A: As long as your company is performing qualified research activities it should be claiming the tax credit. Unused credits can be carried forward for 20 years and backward for one year. The credit can also be applied retroactively to amended returns for the previous three open tax years. This means that companies who go back and amend returns to claim R&D credits for previous years can potentially receive a refund treasury check for taxes it paid before the credit was applied.
Q: What if the project I was working on failed?
A: The R&D Tax Credit law makes no distinction on whether or not the project has to be successful in order to claim R&D credits. The fact that research and development conducted by a company did not turn out a successful product and solution actually proves that the company performed qualified research since it shows that there was significant uncertainty. Not only does this apply to companies that have products fail, service-based firms who work to provide engineering solutions for a client but are never awarded a contract also can qualify.
Q: I work under contract to perform services for clients. Can I still claim the R&D Credit?
A: If your contracts are firm-fixed-price then, generally, yes, you are still eligible for the R&D Credit. The IRS prohibits taxpayers from claiming R&D Credits for what is considered “funded-research.” The definition of funded research has been established through numerous landmark tax court cases. In general, any company performing work under time and material or cost-plus contracts is not considered to be assuming enough risk should the research fail. Contractors that work under fixed-price fees and whose work is subject to inspection, testing, and acceptance are considered to be conducting non-funded research. Additionally, if your client can withhold payment until deficiencies are corrected, or, if your projects contain warranty clauses the R&D Credit may be claimed.
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