Are R&D Tax Credits Convertible to Cash?

R&D Tax Credit

small business

income tax

By
Deborah Roth, CPA
on
August 14, 2023

Navigating the world of R&D Tax Credits often prompts the question: Can these credits be converted into cash refunds? It's a query frequently posed by businesses seeking to maximize their returns on research and development investments. While R&D Tax Credits themselves aren't inherently refundable, they can still yield a financial windfall in the form of cash benefits.

In essence, the R&D Tax Credit functions as a tool to offset a corporation's income tax or to alleviate tax obligations for shareholders in flow-through entities, like S-corporations and partnerships. Typically, this credit is applied to federal taxes within the same fiscal year as qualifying expenditures. Yet, if your tax liabilities are non-existent or the credit surpasses what you owe, a direct refund won't be issued by the IRS.

Industries such as manufacturing, biotechnology, pharmaceuticals, engineering, and software development hold the potential to leverage significant federal and state tax savings, thereby reinvesting in their ventures. If your business, or its stakeholders, are subject to income tax, capitalizing on the research credit is likely advantageous. Generally, businesses claim R&D Tax Credits for the tax years corresponding to qualifying expenditures.

The Carryforward Approach

In instances where your business isn't liable for income tax or your R&D credit surpasses your tax dues, an IRS refund for the unused credit isn't forthcoming. However, businesses have options to employ these surplus credits. They can be applied to the prior year's tax return or carried forward to subsequent years. Many enterprises opt for the 20-year carryforward provision, allocating unused credits to offset future tax liabilities. While this approach defers the cash benefit to a later tax cycle, it's a prevalent way of addressing surplus R&D credits.

Can R&D Tax Credits be Carried Back?

Yes, there's another avenue for capitalizing on excess research credits: carrying them back to the preceding tax year. For example, a company with a $100,000 tax liability and a $225,000 R&D credit can reduce the current year's tax burden to $18,750, utilizing the extra $143,750 credit to recover taxes paid in the previous year. In most cases, the application of these credits to the prior year doesn't necessitate filing an amended return. Shareholders and members of S-corporations and LLCs can similarly implement this tactic for their personal taxes.

Mitigating Payroll Taxes with Credits

Beyond diminishing income tax, R&D Tax Credits can also offset a company's portion of payroll taxes. Corporations or partnerships with gross receipts of $5,000,000 or less during the taxable year, and no gross receipts in the 5-year period before the taxable year, can apply their R&D credits to offset FICA tax in the first quarterly payroll tax payment after filing the corporate tax return. In any given year, the maximum allowable payroll tax offset is $250,000. Unused credits can be carried forward for use against future payroll tax payments.

In the midst of the challenging COVID-19 pandemic, many businesses face the need for cash to sustain operations. For companies employing technical innovation in product development, manufacturing processes, or software creation, the federal R&D Tax Credit proves to be a valuable source of much-needed capital.

How We Can Provide Assistance?

The present juncture presents a prime opportunity to reassess past, present, and future R&D endeavors to harness the potential of the R&D Tax Credit. Irrespective of your industry, if your company's pursuits align with qualifying criteria, it's essential not to leave potential tax savings on the table. At GOAT.tax, we're equipped to guide you through uncovering pivotal tax advantages, fueling your business growth and propelling your next significant undertaking.

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