Quick Refresher on R&D Credit

Quick Refresher on R&D Credit

Ever heard of the R&D tax credit? Maybe, maybe not, but it’s a very useful tool to know about as an entrepreneur while you contribute to the transformation of an ever-growing corner of the market. The R&D tax credit is specially designed to assist and reward all companies that engage in technological innovation – the creation of new ways to test, analyze, and design product enhancements for your consumers. Small businesses can even receive additional benefits that make the credit more advantageous. If you’re looking for a little refresher on this credit or beginner knowledge, here's an overview of what it covers and how to qualify.

What Exactly Is the R&D Tax Credit?

First of all, the R&D tax credit provides a credit for the expenses you incurred while developing a new technology. There are four tests that you must meet to claim the credit:

You're creating or improving something to use in your business.

There is technological uncertainty (i.e., the information you need is currently unknown).

You experiment with or evaluate alternatives. (This includes physical experiments as well as models or simulations.)

The technology involves a hard science, which includes computer science. Social sciences are excluded.

If your development of new technology qualifies for the credit, you can claim most related expenses, such as supplies, wages paid to employees working on the project, and payments to contracted researchers.

Ordinarily, you use the credit against your income taxes. If you have no income tax liability without using the full credit, you can carry the remaining credit forward up to 20 years.

Eligible small businesses may also be able to use the credit to offset up to $250,000 in payroll taxes – so it might be useful to know about it!

Who Qualifies for the R&D Tax Credit?

Virtually any business with a qualifying activity can qualify for the R&D tax credit against income taxes.

To be able to offset payroll taxes, a small business must meet the following two requirements.

Small: No more than $5 million in gross receipts for the current year.

New: No gross receipts for any year before the previous five years.

Why Try to Qualify for the R&D Tax Credit?

Unless you need convincing that fewer taxes are a good thing, the real question is: Why try to qualify for the credit if your qualifying expenses are already tax-deductible? The answer is that credits provide a larger benefit than deductions. Here's how:

With a deduction, you only get back your income tax rate. For example, for every dollar you spend on research, you'd get back 21 cents under the new 21 percent corporate tax rate.

A credit gives you a dollar-for-dollar tax benefit. If you owed $5,000 in taxes before a $5,000 credit, you now owe $0 in taxes.

In addition, credits and deductions almost never apply against payroll taxes, so this is a huge benefit if you qualify.

Note that the credit calculation does prevent double dipping -- the credit and the deduction don't stack together, it's one or the other. But you're still almost always better off with a credit.

What Changed With the 2018 Tax Law?

In light of the new tax laws, two changes were added to the benefit of the R&D tax credit:

The reduced business tax rates mean deductions provide a smaller benefit, and the credit provides an even larger comparative savings.

With the repeal of the corporate Alternative Minimum Tax and the significant reduction in individuals who must pay the AMT, more businesses of all forms will actually see the benefit of the credit rather than having it offset by AMT.

How to Qualify for the R&D Tax Credit?

Determine and self-report whether you qualify. You’ll need to keep records substantiating your expenses as well as proof that the purpose of the expenses was related to the qualifying activities.

File the appropriate form with your income tax return. If you qualify for the payroll offset, you may opt in on this form. Your ability to claim the credit might be restricted if you don't claim it on your original, unamended tax return, so be sure to talk to your accountant well in advance of your filing deadline.

Seek professional advice from your accountant or tax attorney about your overall eligibility and record-keeping requirements before you make any decisions or take any action. Rather be safe than sorry!

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