R&D Tax Credit Qualifications: The Secret To Ultimate Savings

Think the R&D tax credit is just for big companies with fancy labs? Think again!  

Any business can qualify if they meet the requirements, no matter how small. 

This credit used to be limited by something called the alternative minimum tax (AMT). But in 2016, the rules changed. Now, eligible small businesses can use these credits to offset their AMT liability. It's especially useful after recent tax reforms shook things up for corporate tax rates.

The best part: For startups and SMBs, this credit is one of the easiest ways to save big on taxes and operations. It's like finding money in your jacket pocket from last winter…. but way better.

Curious if your company might qualify? Let's break it down. We'll cover how the R&D credit works, who qualifies, and how to claim it. All in the simplest way possible. 

Let’s get going!

What is the R&D Tax Credit & Who Qualifies?

R&D stands for Research and Development. Don't let the fancy name scare you off – it's simpler than it sounds.

Think of the R&D tax credit as the government's way of saying, "Hey, thanks for innovating!" It's a dollar-for-dollar reduction of your tax bill, based on the income and payroll taxes of employees working on R&D projects (not necessarily everyone in the company). There's no limit on how much you can claim, making it the most valuable tax credit for businesses.

Now, who qualifies? If you're designing, developing, or improving processes, formulas, products, or software, you're in! Contrary to popular belief, don’t have to develop something entirely new to qualify. Even small improvements on existing products or technology count.

What Can You claim? 

1. Staff Costs – This is the big one. We're talking employee wages, bonuses, reimbursed expenses, benefits and even contributions to insurance policies and pension funds. If they're working on R&D, it counts. The nitty gritty: these staff costs are part of the 'qualified research expenditures' as defined by Section 174 deductions, which pertain to expenditures associated with research and development activities aimed at resolving uncertainties in product development or improvement.
2. Subcontractors & Externally Provided Workers (EPWs) – Brought in some temporary help for your R&D project? You can claim up to 65% of what you paid them. If they're somehow affiliated with your company, you might even claim 100%. For example, hiring an outsourced accounting firm to calculate the project’s cost qualifies. (And hey, if you need help with that, we know some pretty great accountants!).
3. Software – You can also claim some or all of the costs of using computer software for your R&D projects. Just remember, if you're using it for other stuff too, you can only claim a portion.
4. Consumable Items – This is fancy talk for all the items used to develop the R&D project. They include raw materials and utilities such as energy and water.
5. Prototypes – You can also claim the cost of designing and constructing a prototype if you intend to use it to resolve a technological or scientific uncertainty. However, your claim doesn't qualify if you use the prototype for commercial purposes, such as demonstrating it at a trade show or selling it to a third party.
6. Research Contributions – Claim this is you’re paying someone else to do research for you. Usually, only large companies qualify for this claim.

Benefits of the R&D Tax Credit

First off, it’s not all about you. As entrepreneurs, we know you’re all out there trying to change the world. Good news! The R&D federal tax credits have proven effective in encouraging innovation, improving society, and even boosting the economy. 

And for you? The Tax Cuts and Jobs Act of 2017 introduced significant new tax cuts, which enhanced the benefits of the R&D tax credit by reducing the corporate tax rate, increasing the net benefit for businesses. Which means, you get to save some serious cash.

How serious are we talking? Let's break it down:

• The federal government and state governments pay out billions of dollars per year in R&D tax credits.

• For every dollar you spend on qualifying R&D, you can claim up to 16 cents. That's like a 16% off coupon for innovation!
• Some startups can claim up to $250,000 per year on payroll taxes, while most other businesses can claim up to $1.25 million on their quarterly federal payroll tax returns.
• It’s a dollar-for-dollar reduction on your federal and state income tax liabilities / bills. But, you can't double-dip – no claiming both the credit and a deduction for the same expenses.

The money you save via R&D tax credits can help boost your company’s cash flow to support its operations and facilitate its growth. 

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Example of a Company That Applied for the R&D Tax Credit

Businesses can claim R&D tax credits for a wide scope of activities, and the examples are numerous. Jahnel Group, an agency that helps software creators build amazing software with product design, development, and remote-team supplementation, is an excellent example of how much money companies can save with the R&D tax credit.

Jahnel Group's Switch to Savings: A Tax Credit Success Story

When Jahnel Group partnered with Hiline, they went from old-school accounting to modern financial strategy. The result? A whopping $1.1 million in R&D tax credits over four years.

But that's not all. Hiline's savvy moves, including smart tax planning and a switch in accounting methods, freed up an additional $1 million in cash flow. That's money Jahnel Group could reinvest in their rapidly growing business.

The takeaway? Sometimes, changing your financial game plan and looking beyond the obvious or traditional can lead to million-dollar discoveries. Just ask Jahnel Group!

How to Claim the R&D Tax Credit (Without Pulling Your Hair Out)

Calculating and claiming your R&D tax credit can feel a bit complicated. But, we’re going to help you keep it simple with these three steps. If you still feel stuck, give us a shout and one of our tax experts will lend a hand. 

Step 1: Prove That You Qualify by Meeting Documentation and Record-Keeping Requirements

Time to show off your work! Here are the documents you’ll need:

• Payroll records of the employees involved in the qualifying R&D projects
• Project and meeting notes related to the research (also known as contemporaneous documentation)
• Receipts for equipment and supplies
• Invoices and contracts for any outsourced work
• Blueprints, designs, drawings, patents, and prototypes

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Step 2: Pass the Four-Part Test

The qualifying R&D project must also pass the following four-part test:

1. Permitted Purpose – This is the main requirement. Your project should be about designing, developing, or improving processes, formulas, products, or software. Easy peasy!
2. Technological – The project must also be technological in nature. You know… science-y things like biology, physics, computer science, or engineering.
3. Eliminating Uncertainty – Your project should eliminate some kind of uncertainty about a technological process or product. This generally entails developing a new product or improving an existing product's or process's functionality.
4. Experimentation  – Channel your inner mad scientist. The R&D project must involve an experimentation process. Try stuff out, test things, model scenarios. It's like a science fair, but with tax benefits!

Step 3: Fill Out Form 6765

Next, you need to fill out Form 6765. The form has four sections:

• Section A – Claiming regular credit
• Section B – Claiming alternative simplified credit
• Section C – Identifying additional schedules and forms
• Section D – Claiming payroll tax credits

A few notes: 

• Startups can use the R&D tax credit to offset their FICA payroll taxes under the Federal Insurance Contributions Act, significantly reducing their overall tax burden.
• Section D is only applicable to qualifying startups. The IRS will consider your claim and accept or reject it, depending on your proof.

How to Calculate the R&D Tax Credit Step-by-Step

Calculating the R&D tax credit is a multi-step process that requires careful consideration of qualified research expenses, gross receipts, and the fixed-base percentage. We'll break it down so it's less "advanced calculus" and more "piece of cake." Let's go!

1. Determine Qualified Research Expenses (QREs) – Gather all your R&D-related expenses. This includes wages for employees directly involved in R&D, costs of supplies used in the research, and expenses for contract research.
2. Calculate the Fixed-Base Percentage – You’ll do this by finding the average annual gross receipts for the past four years. This helps set a baseline for your R&D spending. It's like establishing your "normal" so you can see how extra-awesome you've been this year.
3. Calculate the R&D Tax Credit Base – Multiply the fixed-base percentage by the average annual gross receipts for the prior four years. Voila! You've got your R&D tax credit base.
4. Calculate the Current-Year QREs – Add up all the qualified research expenses for the current year. This is your current-year QREs.
5. Calculate the R&D Tax Credit – Multiply the current-year QREs by the fixed-base percentage to determine your R&D tax credit. This calculation shows the amount of credit you can claim.
6. Apply the Credit – Finally, apply the R&D tax credit to your company’s tax liability to get your savings. 

And there you have it! You've just calculated your R&D tax credit. Not so scary after all, right?

Special Rules for Startups and Small Businesses

Startups and small businesses have unique opportunities to benefit from the R&D tax credit. Here are some key rules to consider:

1. Startup Provision Shortcut – If your startup has less than $5 million in gross receipts, you may be eligible to claim the R&D tax credit against your payroll tax liability. That's right – even if you're not profitable yet, you can still benefit.
2. Alternative Simplified Calculation (ASC) – Small businesses can use the ASC method. This method simplifies the calculation by allowing you to use a fixed percentage of your current-year QREs, making it easier to claim the credit.
3. Reduced Documentation Requirements – Startups and small businesses often get a break on documentation requirements. You still need to keep good records, but you won't need to build a paper fortress.

How to Not Leave Money on the Table

The R&D tax credit can seem like a maze of rules and requirements. But here's the thing: it's a maze worth navigating. Just ask the folks at Jahnel Group, who uncovered a cool $1.1 million in R&D tax credits over four years. That's not chump change – it's game-changing money that can fuel your next big idea.

Remember, you don't need to be a tech giant or have a secret lab to qualify. If you're innovating, improving, or just plain problem-solving, you might be sitting on a goldmine of tax savings. So why leave that money on the table? Whether you're a startup or a small business the R&D tax credit could be your ticket to some serious cash flow.

Don't let the paperwork scare you off – with the right partner (hint: that's where we come in), you could be on your way to some pretty sweet tax savings. After all, who couldn't use an extra million bucks to play with? Get in touch today to learn more about how we can help and assist you through the entire process.