The Research and Development (R&D) Tax Credit is a means by which the United States government incentivizes American businesses to continue innovating and expanding their abilities to research and develop better products. As technology evolves and provides a wider range of capabilities in every industry, companies must keep pace with that growth. That can prove difficult as many companies, big and small, face adversity in creating new products or improving existing ones. Even seamlessly integrating new products with those that currently exist is another hurdle that is often tough to overcome.
That's why R&D is so vital to the strength of American businesses. When companies can increase their technical acumen to navigate past the barriers that limit innovation, it provides a stable foundation for our economy. It stimulates competition and the result is a healthier, more robust marketplace However, innovation can be expensive in both financial cost and manpower. There are many variables involved in coming up with new ideas and the methods to implement those ideas into tangible value. More often than not, the trial and error that comes with R&D takes up significant time and money without the return on investment to show for it.
First created in 1981, the credit went by the slightly different name of the Research and Experimentation (R&E) Tax Credit and has been a component of the United States tax code to this day. The goal is to encourage American business owners to continue making substantial investments into their research and development departments for the purposes of conceiving, designing, and producing new products or trade processes, and building upon pre-existing products or trade processes to make them more reliable, more efficient, or higher quality. Consider it a monetary incentive to think bigger and better.
Now, some three decades on, the R&D Tax Credit has not only remained part of the tax code but expanded to make certain provisions permanent. Under the Obama Administration, the Protecting Americans from Tax Hikes (PATH) Act was passed to give taxpayers more accessibility to the credit while renewing certain provisions on a retroactive basis and implementing a series of provisions that had expired as permanent components of the credit.
The R&D Tax Credit has not only remained part of the tax code but expanded to make certain provisions permanent.
These apply to both individuals and businesses and the changes eliminated many of the eligibility criteria that made it difficult for small businesses and startups to benefit from the credit. Under the PATH Act, eligible small business owners may now claim the R&D Tax Credit based on their Alternative Minimum Tax (AMT) for the tax year. This was once restricted under the previous version of the law.
Eligible small businesses are allowed to apply the credit as a way to offset their AMT. There are some stipulations as to the eligibility criteria of a small business seeking the credit. As per the expanded language, an eligible small business must not be a publicly traded company, nor a partnership or sole proprietorship that has an average annual gross over $50 million over the three previous taxable years to the tax year in which the business is claiming the R&D Tax Credit.
In addition, startup companies are now eligible to claim the R&D Tax Credit but the expanded legislation now makes it a refundable credit for startups that have no federal tax liability and can prove gross receipts totaling under $5 million. The Credit is taken against payroll taxes with a maximum of $250,000 over a period of five years. As of January 2016, small businesses that qualify may apply the R&D Tax Credit against their employers' FICA payroll taxes. But in order for the business to be eligible, it must have less than $5 million in annual gross receipts for under five years.
Most companies are often allowed to claim anywhere from 7% to 10% of their qualifying expenses under the federal R&D Tax Credit. Consider a qualified employee earning $100,000 a year on a W2, he or she may equal a tax savings of as much as $10,000 for an eligible employer.
The list of activities that make a business eligible to claim the R&D Tax Credit are as follows. All of these practices have a role in the progress and growth of the business:
The Tax Cuts and Jobs Act (TCJA) has had enormous, far-reaching consequences on many tax issues. One often-overlooked change is The one currently looming on the horizon is the five-year amortization of R&D expenses that went into effect as of January 1st, 2022.
When it comes to claiming R&D tax credits, many taxpayers are unaware of the rules allowing them to carryforward the unused portion of their research tax credit. In most situations, a company that has qualifying research expenses but no income can carryforward the credit to offset tax liabilities on future profit. Any unused R&D credits will carry forward for up to 20 years. In addition to carryforwards, the research tax credit can also be carried back one year.
The Research and Development (R&D) tax credit can benefit startups and small companies through something known as the Payroll Tax Credit. The R&D payroll tax credit became available to qualified small businesses through the Protecting Americans from Tax Hikes Act of 2015 (The PATH Act). This tax law created an opportunity for qualified small businesses to offset all or a portion of their contribution to payroll tax using federal R&D tax credits for up to five years. Prior to this time period, businesses could only take the research credit against their income tax liability.
When it comes to determining how to offset payroll tax with R&D tax credits, business owners and executives interested in saving valuable payroll tax dollars need to understand the following key points.