Yes, The Research & Experimentation Tax Credit, better known as the R&D Tax Credit, is a general business tax credit under Internal Revenue Code Section 41 for companies that incur research and development (R&D) costs in the United States.
Frequently Asked Questions
Short answer: No, it is permanent (effective December 18, 2015).
Long answer: It used to expire but now it is permanent. The R&D tax credit has a history of continual renewals. Since it was created in 1981, it’s been a purely temporary credit. The credit would expire periodically and remain expired for up to a year, then Congress would either extend the benefit retroactively and/or sometimes forward for up to a year.
The Protecting Americans from Tax Hikes Act of 2015 extended the R&D tax credit, retroactively to January 1, 2015, and the law made the credit permanent going forward. Now businesses and their CPAs can take this incentive into account in their long-range budgeting and forecasts. R&D Tax Credits are a dollar-for-dollar offset against past, present, and future tax liabilities. Plus, unused credits can be carried forward for up to 20 years.
R&D tax credits are available for companies of all sizes, particularly because of new legislation enacted in December 2015. Those that claim the credit are involved in a diverse range of industries, all of which are developing or making incremental improvements to their products, processes, techniques, prototypes, formulas, software, etc.
These industries include but are not limited to: software, manufacturing, architecture and engineering (all disciplines), aerospace, and biotech. One key sign of potential eligibility for the R&D tax credit is having engineers, scientists, or product development personnel on staff.
- Defense Contracting
- Engineering (all disciplines)
- IT/Software Development
- Website Advertising/Marketing
- Internet Applications
Manufacturing & Design:
- Consumer Food & Beverage
- Manufacturing (all disciplines)
- Oil & Gas
Environmental & Life Sciences:
- Life Sciences/Medical Devices
- Waste Management/Recycling
If a startup is performing a qualified research activity, it may claim credits regardless of profitability. How it chooses to apply the credits, as Net Operating Loss (NOLs), a payroll offset, or offset against income, is a conversation one of our team members will explore with you.
In the past, credits were not always useful to startups because they were either not yet paying federal income tax, and/or they were years away from turning a profit. Now they may offset a portion of their payroll taxes.
The government recognizes that during the startup phase of a company, significant expenses are incurred in the hope of developing new products and processes that will generate revenue and taxable income in the future. Even though these companies aren’t paying federal income taxes, they are paying a significant amount in payroll taxes.
Under the new legislation, startups described as “qualified small businesses” (businesses with less than $5 million in gross receipts and no more than five years of gross receipts) can now allocate up to $250,000 of federal R&D Tax Credits generated after January 1, 2016 to offset the FICA portion of their payroll taxes.
A company starting operations in 2016 can reduce its payroll taxes by up to $250,000 a year for five years as long as its gross receipts are less than $5 million and its payroll exceeds $4 million.
Established companies may be able to claim the credit if they didn’t have gross receipts prior to 2012.
The R&D credit is calculated on the 2016 tax return as usual, but the taxpayer has the opportunity to claim the payroll portion starting the quarter after the credit is claimed on the federal tax return. Thus, it is important to begin a study sooner than later so a taxpayer can reduce their payroll taxes by July 2017.
A major drawback of the R&D Tax Credit in the past was that companies’ ability to use it was limited if they (or their shareholders, in the case of pass-through entities like S-Corps, LLCs, and LLPs) either 1) didn’t owe federal income tax or 2) were subject to the Alternative Minimum Tax (AMT), hindering eligible companies from taking advantage of the credit.
Now companies may rejoice because recent legislation allows small and midsize businesses to take advantage of the credit more immediately. Small businesses, now defined as having an average of less than $50 million in gross revenue over the prior three years, will be able to offset AMT with R&D credits generated after January 1, 2016.
This provision opens up the credit to small corporations subject to the AMT, as well as pass-through entities (where the credits flow through to shareholders). By removing the AMT limitations, the credit is now more readily available to smaller entities that are stuck paying AMT and even more significantly, credits that may previously have been unusable can now reduce AMT and allow reinvestment in the company.
When claiming any incentive to reduce a company and/or shareholder tax return, there is always a chance of audit. That is why it is extremely important to choose a consulting company that meticulously follows IRS guidelines and regulations and properly documents every credit claimed. Indago prides itself on its thorough approach to every one of our projects. We aim to work with you for the long run!
When claiming the credit in a study, we must identify and substantiate Qualified Research Activities (QRAs). Qualified research is an activity or project undertaken by a taxpayer that must meet four IRS requirements:
1. Permitted Purpose. The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component. A business component is defined as any product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.
2. Elimination of Uncertainty. The taxpayer must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development or improvement, or the appropriateness of the business component’s design.
3. Process of Experimentation. The taxpayer must undergo a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer’s research activities. Treasury Regulations define this as broadly as conventional implementation of the scientific method to something as informal as a systematic trial and error process.
4. Technological in Nature. The process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement.
There are no upfront fees or charges for determining feasibility. Once a company engages with Indago, they will only be charged upon completion of the study with delivery of report and calculations for filing. Indago charges a percentage of the total credits generated. On average, our fees are 33% less costly than our competitors.
Most likely! The majority of U.S. states offer generous state R&D credits in addition to the federal credit. Oftentimes they are filed at the same time as the federal, but some require applications beforehand. Contact one of our friendly tax professionals to learn more about your state opportunity.