When it comes time to do your business taxes, the R&D credit may be one you are hoping can help lessen your tax burden. This is a program that has been around for 40 years! President Ronald Reagan introduced the R&D credit originally when he signed the Economic Recovery Tax Act of 1981 (ERTA). Since then, many small and large businesses have been successfully monetizing the R&D credit to the tune of billions of dollars per year.
But who can claim the R&D credit and what qualifies as an R&D credit? Find out if your company could be eligible — and how to recoup your investment.
What Is the R&D Tax Credit?
First thing’s first: let’s break down what an R&D tax credit really is! Short for “research and development,” this particular tax credit is a federal program that helps business owners who have invested in, well, research and development during the fiscal year.
As the name implies, this functions as a credit on a company’s taxes (similar to the Employee Retention Tax Credit), meaning it will reduce your tax bill on a dollar-for-dollar basis. For example, let’s say your small business owes the federal government $50,000 in taxes this year, but you qualify for a $5,000 R&D credit. You will be able to subtract all $5,000 from the amount you owe the federal government.
So this credit is all about research and development, but what exactly qualifies as R&D? The eligibility is pretty broad, including not only product development itself but a percentage of the costs of new manufacturing processes, quality enhancements, and software development.
How to Qualify for an R&D Credit
There are some important things to think about when considering if your small business might qualify for an R&D credit.
- Did you devote time and resources to creating new or innovative products?
- Did you hire engineers or designers?
- Did you improve existing products?
- Did you develop intellectual property?
All of these things could qualify your small business for R&D credit on your business taxes. And because the R&D credit is retroactive, some small business owners can even claim these tax credits back three prior years. Do you own a start-up? You may even be able to apply an R&D tax credit of up to $250,000 against your payroll tax for five years, for a total of $1.25 million!
Which Industries Qualify for an R&D Tax Credit?
There are a host of different industries that qualify for R&D tax credits — provided they’re doing research and development! You might qualify if your small business falls under any of these industries:
- Aerospace
- Agriculture
- Apparel
- Architects
- Automotive
- Biotech/Life Sciences
- Brewery
- Coating and Adhesives
- Chemical
- Commercial Bakeries
- Construction
- Distribution
- Electronics
- Energy
- Fabricators
- Flavor and Fragrance
- Food Processors
- Food Products
- Furniture Makers
- HVAC
- Insurance
- Jewelry Design
- Job Shops
- Life Sciences
- Manufacturing
- Medical Devices
- Microwave System
- Oil and Gas Refineries
- Package Design
- Pharmaceuticals
- Plastic Injection Molding
- Research and Development Facilities
- Software
- Telecommunications
- Tool and Die
- Transportation
- Waste Management
- Wineries
Which Company Expenses Qualify?
When it comes to the expenses the federal government will accept for the R&D Credit, there are a few important things to note. First of all, 6% to 8% of a small business’ annual qualifying R&D expenses can be applied, dollar for dollar, against its federal income tax liability. If there is a lack of tax liability, unused R&D credits can be carried forward up to 20 years! But, those expenses must be what the IRS considers “qualified.”
Those qualified expenses can include things like:
- Salaries
- Supplies
- Contracts related to research
- Cloud hosting
Are There Any Watchouts?
Make sure you keep your records on all of the R&D in relation to these expenses! When a small business is trying to claim this credit via an amended return, they’re required by the IRS to identify all of the research activities performed plus names of employees or contractors who performed each specific research activity. You will also be required to include the information each individual sought to discover during their R&D activities.
Another important thing to keep in mind when it comes to qualifying for the R&D credit is that research itself must be qualified. The IRS does not allow the following types of research to be counted!
- Research conducted after the beginning of commercial production.
- Research adapting an existing product or process to a particular customer’s need.
- Duplication of an existing product or process.
- Surveys or studies.
- Research relating to certain internal-use computer software.
- Research conducted outside the United States, Puerto Rico, or a U.S. possession.
- Research in the social sciences, arts, or humanities.
- Research funded by another person (or governmental entity).
Determining if your business qualifies for an R&D tax credit can be complicated, but our team of experts can determine if your business is a fit and help you claim the maximum credit. Click here to schedule your free consultation with a member of the ClaimYourAid team to find out if your business qualifies for the R&D tax credit or for other government grants, credits, or refunds!