The easiest examples of research to think about tend to take place in medical laboratories, engineering facilities, and chemical labs. However, companies follow research and development (R&D) methods and processes for various applications in many more industries than just medicine and robotics, and these efforts get funded and taxed in a variety of ways.
As markets mature, the companies that drive the industries behind them get pushed to innovate and remain competitive. Consumer and commercial demands grow, and companies see the need for creating a better means of delivering products and services to the customers that rely on them. This is the concept behind the tax credits the IRS offers to even small companies for increasing research activities. Here’s what you need to know about tax credits for your company’s R&D efforts.
The basic requirements for obtaining tax credits for increasing research activities
There are four main criteria that businesses must meet, followed by a review of qualifying expenses, to determine if they qualify for the generous R&D tax credits that are available:
1. Making an Improvement
Research conducted must result in the development or improvement of a product or process that can be replicated for use beyond a single customer instance or even the firm itself that produced it.
2. Elimination of Uncertainty
That also means there cannot be any existing or pending patent on a like product that a firm claims it has independently developed. It’s crucial to thoroughly check your sources to avoid reinventing the wheel or worse, facing a lawsuit!
3. Process of Experimentation
From concept to hypothesis, simulations must result in documented experiments, modeling, or other testing which can clearly articulate results.
4. Technology & Science
Sound principles of science or engineering in a controlled environment with precision measurements, computations, controls, and independently tested variables.
Qualifying expenses of multiple types can qualify for a tax credit if they are properly documented, including:
- The salaries of those who work directly on the project as well as first-line managers.
- Legal Fees covering the costs of filing for patents.
- Fees for US-Based contractors hired to work on the innovation
- Supplies, materials, and direct expenses.
Special tax credit provisions to consider
There are a number of different industries that can benefit from R&D tax credits, including:
- The battery industry
- Manufacturers and fabricators
- Software developers
- Chemical companies
- Machinery designers and developers
- Engineering groups
- Aerospace and defense
- Automotive corporations
Even if your company type isn’t included on this list, you may still be eligible for a credit. The government wants to award business leaders for increasing research activities to keep the US competitive globally, and it has extended some very generous offers. It has even added a special provision for small businesses that innovate. Businesses with an average gross annual revenue of less than $50 million over the 3 years prior can claim an alternative minimum tax (AMT) tax offset for research expenses incurred. However, these credits must be submitted prior to commercial production using the new technology.
R&D tax credits can only be applied if taxes are owed. If no taxes are owed, then no credit becomes generated. It is still critical, however, to keep track of R&D expenses separately from static and variable operational costs. The IRS allows you to carry forward R&D expenses up to 20 years. A future financial review could reveal prior expenses that can be contributed to subsequent R&D. In this case, you can backdate expenses up to 3 years, and file amended returns which can result in new tax refunds. The IRS provides a complete set of instructions on how to fill out Form 6765.
When it comes to R&D tax credits, the most important thing is to get in touch with an expert tax consultant who can help you determine if your company may be eligible. An experienced advisor will help you determine the types of credit you can qualify for, and how you can apply these credits to your overall tax plan. You can start with your regular tax advisor, and they can refer you to a specialist if necessary.
Staying organized to file correctly
Be sure you keep organized documentation of your projects, including emails, billings, payroll records, specs, project timelines, diagrams, drawings, flowcharts, and meeting schedules. Your documentation will be used to fill out Form 6765. Because there are so many details involved in how to go about claiming these credits, hiring a tax professional to complete a tax credit study is a good way to help ensure accuracy and completeness. Some applications for tax relief will be more beneficial than others, depending on the tax year. The credits are too lucrative for general tax preparation. You wouldn’t want to put in the work to not have a qualifying result from filing your taxes.
This article provides only an introduction to R&D tax credit function and how your business can best benefit for innovation. To get a professional opinion, please reach out to SD Mayer Corporate Tax Team to guide you through the entire process of tax credit for increasing research activities.
Tax accounting is a evershifting world, but you don’t have to navigate it alone. Our certified accounting team can guide you through these complex processes—for you or your business.