Research & Development (R&D) Tax Credits
WHAT IS THE R&D TAX CREDIT?
The R&D tax credit allows taxpayers to offset 10-20% of spending on qualified research expenses (QREs) and basic research payments (BRPs). It does so by reducing federal and state income tax liabilities and, in some cases, payroll tax liabilities. In 2019 alone, businesses throughout the United States claimed an estimated total of more than $18 billion in R&D credits.
The Economic Recovery Tax Act of 1981 created temporary tax credits to encourage innovation. Since then, additional legislation has made these research and development (R&D) tax credits a permanent part of our economy. But even 40 years after they were introduced, far too many companies fail to capitalize on these credits.
B. Riley helps clients take advantage of these credits by analyzing their company's activities to identify qualifying R&D expenses. We work to quantify the total cost of all qualifying activities and design systems to track these costs moving forward. This allows our clients to fully utilize these credits for research performed over the last three years and into the future.
Originally, the IRS required qualifying research to be "new to the world." But a 2003 amendment removed this Discovery Rule, opening up the credits to research that was simply "new to the taxpayer." As a result, virtually any research your company performs with commercial intent can be classified as a QRE. Even spending on unsuccessful research projects can qualify.
QUALIFIED RESEARCH ACTIVITIES: THE R&D TAX CREDIT 4 PART TEST
Businesses in any industry can qualify for the R&D tax credit. To do so, their research activities must meet four general criteria. Often referred to as the R&D Tax Credit 4 Part Test, you must be able to answer "Yes" to each of the following questions to qualify for the credit:
- Do the research activities attempt to eliminate uncertainty?
R&D tax credits apply to research conducted scientifically. And answering questions by eliminating uncertainty is the primary goal of science. You don't need a degree or specialized training to perform the research. Any attempts to fill gaps in knowledge will pass this test. - Does the research involve a process of experimentation?
Qualifying research activities must consider more than one approach in their efforts to eliminate uncertainty. You can explore different approaches with sophisticated techniques like computer simulations and modeling, or simpler methods like trial and error. To pass this test you need only to explore alternative approaches. - Are the experiments technological in nature?
You must rely on the principles of hard sciences to measure the efficacy of your experiments. Hard sciences include chemistry, physics, engineering, and computer science, not social sciences like psychology or economics. Passing this test requires experiments that answer questions with facts and deliver repeatable results. - Is there a commercial purpose for the research?
The purpose of your research must be beneficial in some way for your business. The research needs to attempt to a) develop a new product or service or b) improve an existing one. It doesn't matter if your research ultimately fails at doing so. But the intended purpose of the research must be beneficial to your business in some way to pass this test.
In short, the research activities must set out to answer a technological question via a process of experimentation with the end goal of developing or improving a business component. Any research that meets these criteria and is not specifically excluded should qualify for the R&D tax credit. Market research and quality control testing are two of the most notable exclusions.
If your company engages in research at any scale that satisfies these requirements, we can help to dramatically reduce the associated costs. Speak with one of our tax specialists about how we can help your business save money on its research endeavors.
QUALIFIED RESEARCH EXPENSES
The IRS outlines four kinds of expenses that qualify for the R&D tax credit:
- Wages
Any taxable wages paid to an employee or supervisor directly involved in your research efforts qualify. - Supplies
The credit applies to the cost of any supplies used in your research. - Contract research expenses
At least 65% of fees paid to third parties to conduct qualified research are eligible for the credit. However, your company must retain the rights to the research findings. - Computer rentals and leases
Your claim can include the cost of cloud services, server space, and other computer rental expenses associated with your research.
CAN R&D TAX CREDITS OFFSET STATE TAXES?
Taxpayers with QRA at facilities located in the states below can be eligible for state R&D tax credits.
Please contact us to learn more about the guidelines for your specific state(s).
| Alaska | Indiana | New Mexico |
| Arizona | Iowa |
New York |
| Arkansas | Kansas | North Dakota |
| California | Kentucky | Ohio |
| Colorado | Louisiana | Pennsylvania |
| Connecticut | Maine | Rhode Island |
| Delaware | Maryland | South Carolina |
| Florida | Massachusetts | Texas |
| Georgia | Minnesota | Utah |
| Hawaii | Nebraska | Vermont |
| Idaho | New Hampshire | Virginia |
| Illinois | New Jersey | Wisconsin |
R&D Tax Credit Form
Payroll Tax Credit Form
ELIGIBLE COMPANIES
Almost any company engaged in qualified research activities within the U.S. is eligible for the R&D tax credit. Because this is a tax credit, the primary requirement is that your business pays or expects to pay income tax. Federal R&D tax credits are only eligible to those who expect to pay federal income tax. The same applies to state R&D credits in most of the 30+ states that offer them.
The majority of R&D tax credits are claimed by companies in a only handful of industries. This is partially due to research being more common and costly in specific industries. But the uneven distribution of R&D credits can also be attributed to the fact that countless companies simply don't think to apply for them.
Manufacturing companies collect roughly 65% of all of the R&D credits every year. Information and professional services companies each account for another 10-20% of the credits claimed. Retail and financial services businesses collect another 5-10% each.
But just because your business doesn't serve one of these industries doesn't mean it won't qualify for the credit. Millions of dollars in R&D credits are awarded to companies in real estate, transportation, construction, and countless other industries every year.
HOW TO CALCULATE YOUR R&D TAX CREDIT
- Regular research credits
The traditional method of calculation allows companies to earn a credit equal to 20% of their QREs above a base amount. To determine the base amount, companies must start by calculating their historical research spending in relation to their annual gross receipts. This average is called the fixed-base percentage and can require records dating back to the 1980s, which is why many companies opt to use the ASC method instead.
Once you have the fixed-base percentage of your company's research spending, apply that to the average gross receipts of the last four years. This result is the base amount you'll need to calculate your R&D tax credit using the RRC method.
Your research credit equals 20% of the result of your current QREs less the base amount or 50% of your current QREs (whichever is greater).
As an example, say your company has historically spent an average of 4% of its gross receipts on QREs. Over the last four years, it averaged $1,000,000 in QRE gross receipts but only spent $60,000 on QREs this year. Using the RRC method, your R&D tax credit would equal $4,000.
In this case, the base amount is $40,000 ($1,000,000 x 4%). This is greater than 50% of this year's QREs. So it must be used to calculate the regular research credit.
The RRC method tends to provide larger credits for companies with low base amounts. However, if you don't have the data to calculate your fixed-base percentage, you will need to rely on the ASC method.
- Alternative simplified credits
The ASC offsets 14%
of the current year's QREs that exceed 50% of the average QREs from the last
three years. Thus, calculating your ASC R&D tax credit only requires four
years of QRE data. If your company does not incur QRE in one or more of the
previous three years, the ASC offsets 6% of the total QREs for the current
year.
Using the same
figures we used above, say your company accrued $1,000,000 in QRE gross
receipts in each of the last three years but only spent $60,000 on QREs this
year. Because current QREs are less than half of the 3-year average, the
company would not qualify for an ASC R&D tax credit this year.
These examples illustrate the importance of performing both the RRC and ASC calculations every year. One formula may provide a sizable R&D credit while the other provides nothing.
B. Riley has the necessary expertise to
identify all QREs and calculate the largest possible credit. Even companies
that claim R&D tax credits every year often fail to maximize their full
potential. Our tax experts understand how to carefully report expenses and
revenue, often finding substantial sums that our clients left unclaimed.
HOW FAR BACK CAN YOU CLAIM R&D TAX CREDITS?
Companies may claim R&D tax credits for
any tax returns still within the statute of limitations. In most cases, this
applies to the previous three years. However, if the company experienced
non-taxable years or loss years, they may carry credits forward for up as many
as 20 years.
If your company has never claimed R&D tax
credits, careful analysis of past and present QREs is essential for maximizing
your return. Our understanding of the tax code allows us to offer clients far
greater returns than they can achieve on their own. Don't hesitate to reach out
for help taking full advantage of these lucrative credits.
HOW TO CLAIM R&D TAX CREDITS
To claim R&D tax credits, attach Form
6765 to your company's timely-filed federal tax return. Some
companies may also need to file Form
K-1 in conjunction with 1040 returns, but this is less common. The
process for claiming state R&D credits varies wildly from state to state.
Please reach out to our tax experts for help doing so.
There are no specific requirements regarding
documentation of your research spending. However, in the case of an audit, you
must be able to provide evidence to support your claim. Filing R&D credit
claims as part of an amended return increases the likelihood of an audit. This
makes it all the more important to gather strong supporting evidence for these
claims.
It can be difficult to calculate precise
figures for some research expenses, such as wages for employees who only spend
a portion of their time performing research. In these circumstances, estimates
that are supported by factual evidence are acceptable. Evidence that may help
support your claims include:
- Payroll data
- Company ledgers
- Project documentation
- Lab/test results
- Emails/paper correspondence
- Employee testimony
Without extensive experience in filing R&D
tax credits, most companies fail to claim the full amount they've earned. B.
Riley has helped thousands of clients collect generous R&D tax credits to
offset their research costs. And our fees typically amount to a small fraction
of the additional value we provide.
If your
company performs research of any kind, at any scale, we can help you collect
the maximum credit from both state and federal bodies.
