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Are you reaping the benefits of the research and development tax credit?

Posted by Shivali Anand

August 17, 2021    |     4-minute read (730 words)

Many businesses aren’t benefiting from the R&D tax credit because of common misconceptions about eligibility. Read our blog to find out whether you may qualify.

Even if they make billions, some giant US corporations don't have to pay a lot in taxes. The R&D tax credit is among the most opportune ways to reduce even a small company's tax burden. This credit allows companies to deduct qualifying research and development expenses from taxable income, therefore decreasing the amount they owe to the IRS. And it's not just Amazon and Starbucks that can take advantage of such R&D tax credits. Small-to medium-sized businesses may also be eligible.

What it is

The government created a tax incentive to encourage companies to invest in research (R&D). We've included a brief overview of the credit so you can see whether it applies to your business. If you qualify, you'll want to speak with your accountant or tax lawyer.

Companies that create new or better business components, such as goods, processes, computer software, methods, formulae or innovations that result in new or enhanced functionality, performance, dependability or quality are eligible for the R&D tax credit. It's accessible on both the federal and many state levels, with over 30 states now providing a credit to offset state tax liability.

The basics

To qualify for the R&D tax credit, a company must do technical research and development that is used to produce a new or better product or method. As you strive to enhance functionality, dependability, performance or quality, your work must include uncertainty and experimentation. The data you rely on to perform R&D should be used and recorded in your experimental method. Do you make use of computer modeling? What about engineering programs? Do you want to take physics or chemistry tests? You have to demonstrate that your R&D is technical.

In addition, you'll need to keep track of your research activities so you can verify how much of your money went toward R&D. Payroll records, project lists, data from your ledger costs, emails about research and development activities, notes from researchers and other paperwork, for example, could help fulfill this requirement.

For five years, startups may be eligible for up to $250,000 in R&D credits to offset their payroll tax burden. Qualifying enterprises must have had gross receipts for no more than five years and have gross receipts of $5 million or less in the year they claim the credit.

In other words, you must research to find tech knowledge to build a new or enhanced company component through an experimental procedure.

The use of a laboratory is not always necessary

If you think of R&D as just a firm with a research facility staffed by scientists in white coats, you're mistaken. You may do your R&D at your office or in a test kitchen; wherever you're testing, that's where your R&D demands are fulfilled.

Your R&D efforts may not fulfill the government's standards for credit in some cases. If a client pays you to enhance its product or service, for example, that's a service you're providing that's unlikely to qualify for the credit. Furthermore, if you receive a government grant to fund your R&D, you won't be able to deduct your R&D expenditures under the credit since that would be considered "double-dipping."

Don't let R&D get in the way

Clearly, as with any other tax credit, there are no promises that you will receive a specific tax credit in advance. As an outcome, you might not want to base your choice on whether to conduct R&D on credit. The idea is that if you are working or plan to perform R&D, you should investigate the tax credit. However, regardless of the outcome, it is an excellent business practice to do research and development since it fosters innovation and improvement.

If you already have or are starting an R&D program, your tax expert can tell you if you satisfy the requirements for the tax credit so you can prepare accordingly. It's a good idea to do your homework before making any business choice, just like you would before making any other such decision.

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