Every year millions of dollars go unclaimed by businesses that think they can’t take advantage of R&D tax benefits.
So if you think research and development (R&D) tax credits are only for large corporations or big scientific breakthroughs, you could be missing out on some huge tax breaks for your own business.
Qualifying for an R&D tax credit may be easier than you think. Even making small improvements to a product or a process could qualify you for the credit.
The R&D Tax Credit was enacted in 1981 as an incentive to promote American innovation. These tax credits were originally considered a temporary addition to the tax code, although Congress routinely extended them for one or two-year periods.
In 2015, Congress passed the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act”) which made the R&D tax credit a permanent part of the federal tax code.
The definition of R&D was also clarified. Any company that designs, develops or improves products, processes, techniques, formulas or software may be eligible.
R&D relates to development before commercial production for related U.S. activities — so the credit is especially popular with startup companies.
A tax credit differs from a deduction in that it is a dollar-for-dollar offset against taxes owed or paid. So a tax credit of $1,000 saves you $1,000 in total tax, while a $1,000 deduction might only save you $390 or less (depending on your highest tax bracket).
Calculating the R&D credit can be complex, which is why many small business owners rely on specialized firms to find and apply for their credits.
Most companies that qualify receive an R&D credit equal to 5%-14% of total qualifying expenditures.
Wages paid to employees who participate in R&D activities account for a majority of the expenditures.
The activities can include product development, product modification, or process improvements, as well as other research and development activities.
And since wages tend to be one of the largest expenses for small businesses, the R&D tax credit can be quite substantial.
BONUS TIP: If you or your business has been involved in qualifying R&D activities for the last several years, you may be able to retroactively claim R&D tax credits from the past 3 years. (See how you can get a 3-year review of your taxes here).
The good news is that you may be able to claim an R&D tax credit at the state level, too, in addition to the federal R&D tax credit.
Many states provide R&D tax credits or similar incentives, although the rules are different from state to state.
Here are 15 examples of State R&D tax credits we researched to give you an idea of what you might get:
This is just a sampling. Many other states offer similar tax incentives that allow you to “double-up” on your Federal R&D tax credit.
Several states do not offer (or have eliminated) an R&D tax credit or incentives, but you can still qualify for the Federal R&D credit.
Even though the R&D tax credit has been around since 1981, the tax code around it has gradually evolved over the years. Most CPAs have never studied it because the credit has historically only been used by large corporations.
With the 2015 PATH Act, many more companies gained eligibility. So because of this gradual evolution over the years, many CPAs are not aware or up-to-date on the most recent policies and regulations regarding the R&D credit.
Third-party services that specialize in the R&D tax credit can help fill the gap. They do all the research for you and work with your existing CPA. They will even send your CPA all the completed forms they need so you can get the tax credits you deserve. (See the Action Steps section at the bottom of this article for more information.)
Many businesses perform activities that qualify for the R&D tax credit without realizing it.
The 2015 PATH Act opened the door to many activities that go beyond the lab-coat-style R&D used by giant corporations.
The R&D tax credit can be used by businesses of any size in industries ranging from software development to micro-breweries. If you create or design products or do anything technology-based, improve it, and sell it to customers, you probably qualify.
Industries that commonly qualify include:
Qualifying Activities for R&D tax credit purposes is fairly broad. If your company engages in any of the activities below, it’s definitely worth looking into the R&D tax credit:
Qualifying Expenditures include expenses you can use to determine your R&D credit, such as:
While applying the R&D credit to income tax is the most common way to use it, the R&D tax credit can also be taken as a payroll tax offset, up to $250K per year, by qualified small businesses.
This can be a huge boon, especially for small businesses in a start-up phase.
You are considered a qualified small business if you have less than $5 million in revenue and are within five years of your first gross receipt.
If you don’t have any payroll, the credit can be carried forward to the next quarterly return. The credit doesn’t expire and continues to be available until it can be fully used against payroll tax.
Unused credits can even be saved up and applied upon exit.
We know of companies saving tens of thousands — and even hundreds of thousands of dollars with the R&D tax credit.
Remember, this is a dollar-for-dollar credit, not a deduction. It’s applied directly against taxes owed.
Even using a third-party service to find and apply your R&D tax credit can be cost-effective.
Most of these firms use technology-driven solutions to simplify the process of finding and claiming the R&D tax credit you qualify for. And best of all, they don’t charge you anything unless they find you money.
So regardless of what your company does, it’s worth looking into the R&D tax credit.
The PATH Act guarantees the R&D credit is here to stay — and can likely become an ongoing part of a small businesses’ annual tax strategies.
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