The US research & experimentation tax credit (or R&D tax credit) is a general business tax credit under IRS section 41 for any business that incurs research and development (R&D) costs in the United States. Each year under this program, the US government provides over $10 billion to businesses for developing new or improving existing technologies, products and materials.
Established first in 1981, the R&D tax credit experienced fluctuating status for decades, with Congress periodically renewing it after it expired. Finally in 2015, the R&D credit was signed into permanent law, so US businesses with R&D costs can now confidently account for it in their long-term budgeting forecasts.
In our recent webinar, we chatted with R&D tax credit expert and Boast.ai co-Founder, Chief Strategy Officer, and EVP Lloyed Lobo on the details of the R&D tax credit, and how exactly businesses can optimize their claim, and ultimately use the credits to offset payroll taxes up to $250K per year, to offset AMT, or to reduce income taxes.
Read on to learn more (and find the entirety of our discussion with Lloyed here):
Who can claim?
Though the idea of a “traditional” R&D company typically evokes those in the scientific, professional, and technical services sectors, in actuality these types of company only accounted for about a third of all claims filed in 2013 (the most recent year of available IRS data). In 2013, a substantial amount of companies in the following sectors (in order of significance) also filed claims:
- Wholesale and retail trade
- Management of companies (holding companies)
- Administrative support and waste management services
- “Various services,” which includes educational services; health care and social assistance; arts, entertainment, and recreation; accommodation and food services, and more
- Finance and insurance
- Agriculture, forestry, fishing, and hunting
At the end of the day, any company in any sector can qualify for the R&D tax credit if they can prove they perform R&D activities.
How do I qualify?
Regardless of the industry, size, or revenue of your business, to determine your eligibility for the R&D tax credit, you need to ask yourself these 5 questions
- Was there a scientific or technological uncertainty that could not be removed by standard practice/engineering?
- Did the effort involve formulating a hypothesis specifically aimed at reducing or eliminating the aforementioned uncertainty?
- Was the adopted procedure consistent with the total discipline of the scientific method, including formulating, testing, and modifying the hypothesis?
- Did the process result in a scientific or technological advancement?
- Was a record kept of the hypothesis test and results as the work progressed?
The IRS specifies that any R&D activities should be technological in nature (hard sciences, such as engineering, physics, chemistry, biology, or computer science) and involve technical uncertainty, a process of experimentation, and a qualified purpose.
Want more detail straight from the horse’s mouth? Hear the full discussion with R&D expert Lloyed Lobo in our Maximizing Your U.S. R&D Claims webinar.
What can I claim and recover?
In general, you can claim the salaries of employees in the US, materials consumed in R&D, and US subcontractors costs.
The amount you can recover is fairly substantial, as outlined below:
- 6% of eligible expenditures, or
- 14% of half of the average R&D expenditures over the past three years (if expenditures remain constant over a three years period, this method results in a 10% credit)
- This differs by state, but
- For businesses in California, you can claim 15% of eligible expenditures over the past three years
How can I use my tax credits?
There are a few options to utilize your recovered costs; you can:
- Reduce federal or state taxes owning, which you can carry back 1 year, or apply in the current year, or carry forward 20 years
- Apply the credits toward FICA payroll tax liability of $250,000 per year if you are either pre-revenue or you had less than $5 million in gross receipts for the tax year with no gross receipts for more than 5 years from the tax year
- Apply the credits against the Alternative Minimum Tax (AMT)
Note: The ability to use tax credit toward payroll tax and AMT was implemented on January 1, 2016, so it can’t be applied before this date.
How do I optimize my claim?
The best way to optimize your claim and ensure your passing of an R&D tax review is to emphasize consistent technical documentation that:
- Includes dates,
- Is documented at the time the work was completed,
- Highlights technical challenges, and
- Captures any iterations undertaken to attempt to resolve said challenges
In general, you should be documenting all hypotheses and how they were tested — tracking hours worked by project and activity. When it comes to the IRS, the more accurate and detailed the information, the better.
*Note: The materials available at this website are for informational purposes only and not for the purpose of providing legal advice.