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.

What is the R&D Tax Credit?

R&D tax credits, also known as the Research and Development credit, enable businesses to potentially reduce their federal income tax. Taxpayers might qualify for the credit if:

They paid for (or incurred) qualified research expenses.
The expenses have been for qualified research activities.

R&D tax credits enable businesses to potentially reduce their federal income tax.

Considerations and Additional Factors Relating to the R&D Tax Credit Carryforward

There are a few factors affecting the rules of the carryforward, which include the AMT Offset, the 25/25 Limitation, TCJA Effects on NOL Carryforwards, and state-specific carryforward rules.

The Alternative Minimum Tax (AMT) Offset

Prior to the enactment of the PATH Act, taxpayers were unable to realize the full benefit of their R&D tax credits in a given year due to AMT restrictions. The AMT limitation prevented qualified companies from utilizing 100% of the tax credit; consequently, the excess R&D tax credits were carried forward.

The PATH Act 0f 2015 was one of the first initiatives to make significant changes in the relationship between AMT and the R&D Tax Credit. For tax years beginning after December 31, 2015, small businesses can offset AMT using the research credit against. However, any carryforwards from tax years prior to 2016 are still limited by AMT.

Fortunately, the Tax Cut and Jobs Act (TCJA) eliminated AMT for C-corporations providing these companies the opportunity to further reduce their tax bills using past, present, and future research tax credits.

25/25 Limitation

There is one rule in place that restricts taxpayers from offsetting a percentage of their tax liability, known as the 25/25 Limitation. The 25/25 Limitation restricts taxpayers with over $25,000 in regular tax liability from offsetting more than 75% of their tax liability using the credit (Sec. 38(c)(1)).

TCJA Effects on NOL Carryforwards

For all taxpayers, the TCJA amended Sec. 172(a) for any tax year beginning after Dec. 31, 2017, by adding a new limitation on the use of net operating losses (NOLs) that restricts their use to 80% of taxable income. The new 80% taxable income limitation may require some taxpayers to seek additional tax savings opportunities, such as the R&D tax credit.

Under the CARES Act, NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2021 may be carried back to each of the five tax years preceding the tax year of such loss. In addition, the CARES Act also temporarily removes the 80% limitation, reinstating it for tax year beginning after 2020.

State R&D Carryforward Rules

Many states allow unused credit to be carried forward. Some mirror the federal carryforward guidelines of 20 years and others range from zero to eternity. In California, there is actually no limit on how far forward you can apply the R&D tax credit carryforward.

R&D Tax Credit Carryforward Case Study

Let’s say there is a blockchain company that is eligible for the R&D tax credit. The company experienced losses from 2016 through 2019, a total of 3 years. Then by 2020, the blockchain company is now profitable. They choose to claim the R&D tax credits for 2020 as well as 2016 through 2019. This creates a carryforward that they plan to use in 2020.

The blockchain company calculates a total of $100,000 in research tax credits and has a federal tax liability of $120,000. But due to the 25/25 limitation, it can only apply $90,000 of the credit to offset its tax liability. The remaining $10,000 will be carried forward to the subsequent year.

How We Can Help

GOAT.tax is powered by Source Advisors, a leading tax consulting firm providing R&D tax credits for almost 4 decades. Founded on the basic principle that the R&D tax credit should be available to companies of all sizes without fees burdening the benefit, the GOAT.tax automated software platform is backed by 305+ years of collective R&D tax credit experience. This is what sets us apart from any other platform. Our people and our experience.

Now is a good time to reexamine prior, current, and future R&D activities in order to take advantage of the R&D tax credit, regardless of industry. If you think your company might be performing work that qualifies, don’t let the potential tax savings go unclaimed. Source Advisors can help you uncover vital tax savings to reinvest in your business and fuel your next big project.

Frequently Asked Questions:

In order for a business to qualify for the research tax credits, it must have paid for or incurred expenses related to qualified research activities. Common industries that qualify include manufacturing, software and software development, engineering, financial services, and many more.

The R&D tax credit can potentially help business lower their federal income tax through the following qualified research activities:

  • Creating improved products, processes, formulas, software, and techniques
  • Automating or improving internal manufacturing processes
  • Designing tools, jigs, fixtures, and molds
  • Integrating new equipment
  • Development of data centers, big data, and data mining tools
  • Integration of APIs and other technologies
  • Development of financial or pricing models
  • Hiring outside consultants to perform any of the listed activities
  • Manufacturing new or improved products
  • Developing prototypes, first articles, models
  • Evaluation of alternative materials
  • Development of firmware
  • Network hardware and software development and optimization
  • Developing simulators
  • Development of risk management systems

There are no size requirements and there are no industry requirements.

The Research and Development Tax Credit requires that IRS Form 6765 Credit for Increasing Research Activities be completed with your income tax return. There are two primary methods for computing the R&D tax credit with your income tax return, which includes the Regular Credit (RC) Method and the Alternative Simplified Credit (ASC) Method.

Taxpayers can choose which method they would like to have utilized for calculating their potential tax benefit, however, each method offers specific advantages and disadvantages. Our team at Source Advisors can determine the best calculation method based on your situation.

There are also four sections of IRS Form 6765 that must be completed:

Section A: The first section is for any business attempting to claim the r d tax credit.

Section B: This section is for businesses electing to utilize the ASC calculation method.

Section C: This section contains further documentation based on your specific business setup.

Section D: This section is required for small businesses who fall under the payroll tax election.

Yes, in most situations, the r d tax credit can carryforward for up to 20 years. If you need help with your R&D tax credit on your federal income tax return, please contact us.

You can claim the R&D tax credit for up to 20 years. You can also carry the research tax credit back one year.

A company with qualifying research expenses with no income can carryforward its r d tax credit for up to 20 years. This carryfoward will offset tax liabilities on future profit. To claim the R&D tax credit, IRS Form 6765 must be completed. The one exception to the carryforward is the 25/25 Limitation, which restricts taxpayers with more than $25,000 in regular tax liability from offsetting more than 75% of their liability using the credit.

The R&D payroll tax credit is a tax incentive designed for qualified businesses to offset their payroll tax. New companies that perform research and technology development activities can apply up to $250,000 of research credit against payroll tax liability. These R&D credits can be carried forward for up to 20 years.

A business must meet each of the following criteria to qualify for the R&D payroll tax credit:

  • Have 5 years or less in revenue
  • Have less than $5 million in revenue in the current year
  • Have conducted qualifying research activities and expenditures

The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.

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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.

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