The R&D Tax Credit, also known as the Research and Experimentation (R&E) tax credit, provides a tax incentive to U.S. companies so that they can invest the savings by spending on research and development activities related to the improvement of processes, inventions, formulas, products, or software. This development tax credit remains a reliable way for companies to reduce income tax liabilities. Read on to find out if your business is eligible.
The R&D Tax Credit allows startups who meet certain requirements to use the credit against their federal tax bill and claim up to $250,000 towards FICA for payroll tax savings. The requirements for payroll tax savings include:
The R&D Tax Credit has existed as a temporary year-to-year measure since 1981, requiring congressional approval every few years. When enacted, its sole purpose was to encourage investment and innovation in the US. In 2015, with the passage of the “Protecting Americans from Tax Hikes Act” (PATH), the R&D Tax Credit became permanent. In addition, the credit can now be used to offset payroll taxes (as well as income taxes), which allows even companies with net losses to receive the credit immediately.
Taking effect in 2022, the Tax Cuts and Jobs Act (TCJA) made changes to the tax credit. Companies no longer have the option of deducting R&D costs in the same taxable year and will be required to amortize their Section 174 deductions over five years for costs incurred domestically or fifteen years for costs outside of the United States. This applies to expenses incurred beginning after 2021.
The IRS has released Revenue Procedure 2023-111 to provide taxpayers with a method to obtain consent under Section 446 to change methods of accounting for specified research expenditures.
In addition, President Biden recently signed into law the Inflation Reduction Act of 2022. For tax years beginning after Dec. 31, 2022, the Act doubles the maximum R&D tax credit qualified startups can apply against their payroll tax liability, from $250,000 to $500,000 per year.
To claim the R&D Tax Credit you must file IRS Form 6765 with your income tax return. This will require gathering all the necessary documentation needed to support the claim. This is why it is recommended that you consult with or seek the services of a professional as they will be able to help you determine which expenses qualify. Finvisor is equipped with qualified CPAs and accountants ready to help you claim your credits.
Each company is eligible for up to 250% of their average monthly payroll expense, with a salary cap of $100,000 per employee, with a maximum of $10 million.
Once you have determined whether your business qualifies for the credit, there are two methods commonly used to calculate the R&D tax credit:
Under the RRC method, the credit equals 20% of a company’s current year qualified research expenses (QREs) that exceed a base amount. The base amount is determined by applying the taxpayer’s fixed-base percentage of gross receipts spent on QREs to the prior four years’ average gross receipts of the company. Entities must have the data necessary to determine their QREs to use this method with ease.
The ASC is calculated by multiplying the amount of QREs for the taxable year that exceed 50% of the average QREs for the prior three tax years by 14%. If the taxpayer has no QREs in the prior three tax years, the credit equals 6% of the QREs for the current credit year. This is the most commonly used method due to its ease and more accessible prior record requirements.