R&D Tax Credit

R&D Tax Credit

What is the R&D tax credit? The R&D tax credit was enacted in Economic Recovery Tax Act in 1981. The purpose of the R&D tax credit was to reverse the decline in the U.S. research spending at that time by providing an incentive that was premised on benefiting increases in year-over-year research spending. Additionally, many states offer this R&D credit to businesses who do qualified work within their state lines, but their calculation methods may differ from the federal methods. Often, companies that are meant to benefit from these credits overlook this opportunity. For purposes of the R&D tax credit 2022, qualified research generally constitutes private sector or commercially driven development efforts intended to exceed, refine, or expand or a scientific or technological field. The R&D tax credit qualifications are laid out in the tax code through a R&D tax credit 4-part test which comprises of creating or improving a business component, discovering information that is technological in nature, eliminating technical uncertainty, and conducting a process of experimentation. The first part of the test states that the research needs to be centered around a new or improved business component, such as a process, product, technique, software, or formula. The second part of the test states that the qualifying activities must be technological in nature meaning the activities must rely on the hard sciences such as, biology, chemistry, physics, engineering, or computer science. The third part of the test states that the qualifying activities must have technical uncertainty. The technical uncertainty can lie in three areas, capability (Can the project be accomplished?), the method (How is the project going to be accomplished?), and functional design (What is the best way to do the project?). After the third step is met, the fourth step states that there must be a process of experimentation to test out those technical uncertainties, such as computer simulation, engineering calculations, physical testing or systematic trial and error. For the R&D tax credit in 2022 the IRS issued Memo 20214101F, which details the information that taxpayers will be required to include in the R&D tax credit claim for the refund to be considered valid. Beginning January 10, 2022, taxpayers must submit this information with their amended tax returns but not in their original filed research and development tax credit for 2022.

R&D Tax Credit Examples

Companies have options in how they want to calculate their R&D tax credit. McGuire Sponsel uses a R&D tax credit excel spreadsheet to calculate the R&D tax credit. Below are a few R&D tax credit examples to show the different expenses that can be included as well as the different calculations that can be used. The first R&D tax credit calculation is the alternative simplified R&D credit calculation. For the companies that cannot adequately substantiate qualified research expenditures for the standard or start-up calculation methods or generate fixed-base percentages that significantly limit the credit, the IRC §41(c)(5) provides an alternative calculation method called the alternative simplified credit. To calculate the R&D tax credit 2021 there are certain expenses that can be included. The R&D tax credit qualified expenses are wages of qualified employees, supplies, computer leasing, and contract research expenses. The wages of directly, technically involved individuals are the main driver of the R&D tax credit. Qualified supply expenses include any tangible, non-depreciable materials used in the qualified research activities. Computer leasing expenses include any rental or lease of computers or cloud computing used in the qualified research activities. Contract research includes the expenses incurred by a third-part consultant or sub-contractor assisting with development activities. On October 15, 2021, the IRS issued Memo 20214101F, which detailed the information that taxpayers will be required to include for an R&E Credit claim for refund to be considered valid. To make a R&D tax credit prior year adjustment, additional information will be required to substantiate that adjustment. Starting on January 10, 2022 taxpayers will submit this information with their amended tax returns, which can be done through a written statement. Businesses with less than $5 million in annual gross receipts and no gross receipts for any tax years preceding the five tax year period ending with the current tax year may claim up to $250,000 of the R&E Credit amount against the employer portion of the Social Security payroll tax. The R&D payroll tax credit can be claimed on Section D of Federal Form 6765. The amount from the 6765 is incorporated into form 8974 and is filed with the 941 for the quarter that begins after the income tax return with the 6765 is filed.

How To Claim R&D Tax Credit

How to claim the R&D tax credit? To claim the R&D tax credit, you must file IRS Form 6765, Credit for Increasing Research Activities. The R&D tax credit Form 6765 is used to figure and claim the credit, elect the reduce credit under 280C, and elect and figure the payroll tax credit. The Form 6765 instructions are laid out into four basic sections in which businesses must fill out. Section A should be completed to claim the standard credit and has eight lines of required information. Section B should be completed to claim the alternative simplified credit. Section C identifies additional forms and schedules that warrant reporting based on the business structure. Section D is only required to be filled out for qualified small businesses making the payroll tax offset election. If a company is conducting qualified research activities in California, they can claim the California state credit. Taxpayers wanting the California R&D credit utilization must fill out California research and development tax credit form FTB 3523 and file the form with their federal returns. The Form 3523 instructions are laid out into a few basic sections in which business need to fill out. Similar to the federal 6765 research and development form, Section A should be completed to claim the standard credit, Section B should be completed to claim the alternative simplified credit, and Section C is the available research credit.

R&D Tax Credit Calculation

Before a company can calculate and claim the R&D tax credit, they must understand how a R&D credit calculation works. Once a company’s projects are qualified, the next step is to find the amounts that can be used as R&D tax credit qualified expenses. There are four main expenses that can be used for the R&D tax credit calculation: wages, supplies, computer leasing, and sub-contractors. After all these expenses have been found, the next step is to calculate the amount of R&D credit for the given year. There are three main calculation methodologies that can be used to calculate the research and development tax credit, there are certain benefits to consider when deciding on choosing the R&D regular credit vs. simplified credit. Ever since June 3, 2014, companies can elect the alternative simplified credit method (ASC) or the start-up method. The ASC method gives companies an easier option to calculate the R&D credit. The alternative simplified R&D credit calculation does not need to use gross receipts unlike the standard and start-up methods. The alternative simplified credit requires a company to look at the current QREs and the ones from the previous three years. How to calculate the fixed-based percentage for the R&D tax credit? For the start-up/standard calculation, the fixed-based percentage will either be 3.00% for start-up companies who have five or less years of QREs, or a ratio of the QREs to gross receipts. Once the fixed based percentage is calculated then McGuire Sponsel will enter that percentage into a R&D tax credit excel spreadsheet that will assist with the calculation of the R&D tax credit.

R&D Tax Credit Software

This section will be discussing how software can be utilized and how calculate the R&D tax credit with the addition of the software aspect. There are some businesses who are using qualified R&D tax credit software and can claim some of those expenses. A company’s software research must be distinguished as either R&D credit internal use software or non-internal use software and pass specific qualifications. R&D software that is considered internal use software will be software that is developed for use in general and administrative functions that facilitates and supports the taxpayer’s business component. Internal use software must pass the four-part test and the high threshold of innovation test: commercially unavailable, innovative, and significant economic risk. Non-internal use software is software that was not developed primarily for taxpayer’s internal use and developed for either commercial sale, lease, license, or marketed to third party, enables interactions or functions between taxpayer and third-party, and must pass the four-part test as well. R&D tax credits technology companies usually have some sort of cloud computing that they utilize. These cloud computing costs can be claimed as a computer leasing expense. Examples of cloud computing platforms that could potentially be claimed under computer leasing are: Amazon Web Services, Microsoft Azure, Google Cloud, Etc.)