By Alex Pak on April 20, 2022

How to Calculate R&D Tax Credit

If you are a taxpayer planning on claiming the Research and Development (R&D) Tax Credit, you need to decide how to calculate the credit and which method is the best for your business. This is a critical step in preparing your tax return as the credit can be highly lucrative for a taxpayer facing a significant tax liability for the filing year.

Even more importantly, making an informed decision on the calculation method must be done before filing your IRS Form 6765. Once you file using your selected calculation approach, that choice can not be changed with an amended return after filing.

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Calculation Methods

When a taxpayer elects to claim the R&D Tax Credit, the decision over calculation methodology needs to be addressed. There are two options to consider - the Regular Credit (RC) and the Alternative Simplified Credit (ASC).

The choice of two methodologies gives companies the ability to cherry-pick the calculation that offers the greatest financial benefit.

Regular Credit (RC)

Choosing the regular credit calculation method offers a credit of 20% of the Qualified Research Expenses (QRE) over the base amount. To determine the base amount, a company must apply the historical percentage of QREs to an average of four years of annual gross R&D expense receipts prior to the filing year. For corporations that were conducting operations during the 1980s or earlier, additional information must be submitted.

Alternative Simplified Credit (ASC)

The most significant difference from the RC calculation method is the use of Qualified Research Expenses over a previous three-year record instead of the previous four-year average of gross R&D receipts. This would make the ASC method an appropriate choice for corporations that have insufficient historical percentage information to calculate the base amount in order to ascertain whether or not they qualify to claim the credit and submit their return.

Which Method is Best?

The choice of two methodologies gives companies the ability to cherry-pick the calculation that offers the greatest financial benefit. This decision can be made on a year-to-year basis, therefore, a business might choose to elect the ASC method one year and the RC method the next, whichever calculation works best for that filing year. But choosing the correct method takes some careful consideration. For instance, the ASC may offer a simplified methodology for calculating the credit, but it may not always offer the highest yield. In fact, companies with higher base amounts or incomplete information for the base period may find greater advantages than with the RC method. As for the RC method, this option will typically benefit new startups or companies with minimum base amounts.

Calculating the Credit using Alternative Simplified Credit (ASC) Method:

The Alternative Simplified Credit equals 14% of a company's QREs that were spent over the current filing year over 50% of the average Qualifying Research Expenses over the previous three-year period. In the event the company has no QREs for that period, the credit switches to a calculation of 6% of the Qualifying Research Expenses over the current filing year.
The calculation of the ASC is a four-step process in the following order:

Compute the average QREs for the previous three tax years period
Multiply the average QREs amount by 50%
Subtract 50% of the three-year average from the claim year’s QRE amount
Take the result and multiply that by 14%

280C Election

Sec. 280C was enacted to prevent taxpayers from receiving a double-benefit from both a tax credit and a tax deduction for the same expenditures. Section 280C provides taxpayers with a reduced credit in lieu of reducing the deductions.

When the 280C is not elected, taxpayers must reduce 174 deductions by the amount of the credit claimed for the tax period. Alternatively, when making the 280C election, the credit amount is reduced by 21%, and no 174 deduction adjustment is needed.

The 280C election is made annually on Form 6765 and cannot be changed on an amended return. However, this election can be made on an amended return if a blank Form 6765 was filed in the original timely filed return (including extensions) and clearly indicated the taxpayer’s intent to make the Section 280C election in the future – also known as a “protective” election.

Defining Qualifying Research Expenses (QREs)

Employee wages and contract expenses may be eligible for the R&D tax credit if the labor is performed in the United States. Supplies, defined as tangible raw materials used in the R&D process that were not capitalized or depreciated, may qualify, as well.

General and administrative costs, on the other hand, typically are not eligible. This is true for activities that were wholly or partially conducted in support of qualified research.

Employee Wages:

For wages to qualify for the R&D tax credit, employees must perform qualified research activities, such as:

Conducting or executing the qualified research (e.g., testing a manufacturing prototype)
Directly supervising the qualified research (e.g., managing a team of software developers)
Directly supporting qualified research (e.g., organizing test results on formulation trials)

Wages have the biggest effect on how much or how little credit a company can generate. In most cases, wages are the most significant single qualified expense category for most taxpayers. In order to determine how much of your total wage pool would qualify for the credit, you need several things:

Employee Name
Job Title
State
W2 Box 1 Wage
Qualified Percentage of Time.

Consumed Supply Expenses:

Qualified supply expenses are defined as tangible properties directly used in research activities that were not capitalized or depreciated. For example, raw materials used to fabricate and test prototypes would be eligible, but the research facility itself, depreciable equipment or general office materials would not.

Subcontract Expenses:

Much like qualified wage expenses, qualified contract research expenses include time spent conducting or executing qualified research. The difference, however, is that these activities are performed by a third party, not the business entity itself.

According to IRS guidelines for contract research, businesses must maintain substantial rights to the research performed by the contractor and bear the economic risk of the contractor’s development.

With an unmatched combination of our R&D tax credit experience, technology, and support, our GOAT.tax platform makes it simple for businesses to claim your tax credit in a few easy steps. Contact us for a free demo and onboarding, or signup here.

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Maximizing Cash Flow Through Government Tax Opportunities

Amid the ongoing challenges posed by COVID-19, numerous small and midsize businesses are grappling with maintaining cash flow, operational capabilities, and their internal research and development initiatives. While the Coronavirus Aid, Relief, and Economic Security (CARES) Act did extend financial aid to these COVID-19-affected enterprises through emergency grants, retention tax credits, and forgivable loans, these solutions offer only temporary cash flow relief, falling short of providing lasting solutions.

Deb Roth

August 14, 2023

Understanding the R&D Tax Credit Carryforward Period

The R&D Tax Credit Carryforward Period refers to the duration during which unused portions of research tax credits can be applied to offset future tax liabilities. This provision is often overlooked by many taxpayers who are eligible for R&D Tax Credits. In most cases, companies that have qualified research expenses but lack current income can carry forward these credits to offset taxes on forthcoming profits. The carryforward period allows credits to remain applicable for up to 20 years. Additionally, the option to carry back credits for the previous year is also available.

Deb Roth

August 14, 2023

Are R&D Tax Credits Convertible to Cash?

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.

How to Calculate R&D Tax Credit

Calculation Methods

Regular Credit (RC)

Alternative Simplified Credit (ASC)

Which Method is Best?

Calculating the Credit using Alternative Simplified Credit (ASC) Method:

Which Industries Qualify?

Aerospace

Tool & Die

Metal Fabrication

Plastics & Injection Molding

Consumer Products

Manufacturing

Architecture & Engineering

Food & Beverage

Financial Services

Mortgage & Banking

Software Development

Chemical

Contract Manufacturing

Construction / MEP

Pharma

Oil & Gas