Savvy business owners are always on the lookout for valuable tax breaks. One potentially lucrative tax break often overlooked by businesses is the research and development (R&D) tax credit.
Unfortunately, some business owners think that the R&D tax credit is available only to technology firms or large corporations. But this isn’t the case: Any size company in any industry can claim the credit if it meets certain criteria.
The four-part test
A simple test can determine whether or not your business qualifies for the R&D tax credit. To qualify, your business must perform activities that meet at least one of these four criteria:
- They attempt to eliminate technical uncertainty associated with the development or improvement of a product or process.
- They try to resolve a technical uncertainty by conducting simulations, modeling, hypothesis testing or another method of experimentation.
- They are technological in nature and based on sound principles of the hard sciences, such as engineering, physical science or computer science.
- They result in the creation of a new or improved product or process, such as increased performance, functionality, quality or reliability.
Within these parameters, there’s a wide range of activities that could qualify for the R&D tax credit. These include, but aren’t limited to, software development, certification testing, automated manufacturing processes, design tools, patents, and dies and molds.
Note: A few activities are specifically excluded from consideration for this tax credit. These include management studies, efficiency surveys, ordinary testing and inspections, consumer surveys, and the acquisition of patents or models.
Expenses that qualify
The IRS identifies several main categories of expenses that qualify for the R&D tax credit. These include:
- Salaries paid to employees working directly on the activities and their front-line managers,
- Fees paid to U.S.-based contractors,
- Legal fees paid to obtain patents, and
- Supplies used in the course of performing the R&D activities.
You can apply up to 9.1% of eligible R&D expenses as a credit against your federal income tax liability on a dollar-for-dollar basis. Plus, your state might offer a separate R&D tax credit. Many state programs mirror the federal rules that dictate which kinds of R&D activities and expenses qualify.
If your company has no taxable income in a particular year, you can carry R&D tax credits forward for up to 20 years to offset taxable income in the future. You also can claim the credit retroactively for the past three years by filing amended returns.
Permanence and offsets
After many years of being retroactively extended at year end, the R&D tax credit was finally made permanent in a law passed in December 2015, effective for 2016 tax returns. In addition, new offsets were added that could make the R&D tax credit even more valuable.
One of these is a payroll tax offset for certain start-ups that have gross receipts for five years or less and average gross receipts of less than $5 million during this time. If such companies don’t owe any income tax in a particular year, they can use the R&D tax credit to offset up to $250,000 in payroll taxes.
Additionally, businesses with $50 million or less in gross receipts can claim the credit against alternative minimum tax (AMT) liability.
Think it over
If you didn’t think your business could qualify for the R&D tax credit, it may be time to think again. Talk with your tax advisor about the potential benefits of this valuable tax saver.