Research & Development (R&D) FAQs

Research & Development (R&D) FAQs

What is the Research & Development Tax Credit?

The Research and Development (R&D) tax credit, also known as the Research and Experimentation (R&E) tax credit, is a United States government-sponsored tax initiative.

It results in a dollar-for-dollar reduction in a company's tax liabilities and is one of the best things American businesses can do to reduce their liability tax.  Companies can submit documentation to file using IRS Form 6765.

The research and experimentation tax credit was essentially designed as an incentive to make research activities more affordable for businesses, strengthening American innovation.

My start-up is not profitable, do I still qualify for the R&D Tax Credit?

Yes, profitability does not affect qualification. However, if you are not profitable, you either A) have to qualify as a small business start-up to apply the credit against your payroll taxes, or B) carry forward the credits until you have regular tax liability. The qualification for small business payroll tax offset is less than five (5) years of gross receipts history, and less than $5MM in gross receipts during the tax year in which the credit is being claimed.

In measuring the $5 million limit, returns and allowances and any predecessor entities are taken into account in determining gross receipts for a tax year. Rules used in determining the base amount in measuring the regular research credit do not apply.60 Where an entity's tax year is less than 12 months, gross receipts are annualized by multiplying the receipts for the short period by 12 and dividing the result by the number of months in the short period.

To make the Sec. 41(h) payroll tax credit election, the taxpayer completes Section D, "Qualified Small Business Payroll Tax Election and Payroll Tax Credit," of Form 6765, attaching the form to the taxpayer's timely filed (including extensions) return for the tax year to which the election applies.81

Section D of Form 6765 requires checking a box declaring the filer to be a QSB (line 41) and then entering the portion of the research credit that the filer elects as a payroll credit, not to exceed $250,000 (line 42). For filers that are not partnerships or S corporations, the filer is to report its general business credit carryforward, if any (line 43). Finally, the filer reports, in the case of a partnership or S corporation, the lesser of the calculated research credit or the portion (up to $250,000) of the credit elected to offset payroll tax. In the case of an individual, the filer reports the least of the calculated credit, the amount of the election (up to $250,000), or the filer's general business credit carryforward (line 44).

For a partnership or S corporation, the Form 6765 is attached to the entity's timely (including extensions) filed return,82 i.e., a Form 1065, U.S. Return of Partnership Income, for a partnership83 or a Form 1120S, U.S. Income Tax Return for an S Corporation, for an S corporation.84 If the QSB is an individual, the Form 6765 is attached to the individual's return.

My Business is closed now, can I still apply for an R&D Tax Credit?

Closed businesses may amend tax returns from previous years to claim R&D credits if they were profitable and paid taxes in those years, potentially resulting in a refund.

How much money can I get back from the R&D Tax Credit?

The amount of credit varies based on a variety of factors including amount of qualified expenses, historic R&D spend, and calculation method. There is no maximum limit or minimum amount of expenses that would affect qualification. There is a limit, however, to the small business payroll tax offset which is $250,000 per year. If you are applying for a payroll tax offset and exceed the $250,000 annual credit limit, then the remaining credits will just be applied to your regular tax liability.

How soon can I get my money after I claim the R&D Tax Credit?

The tax credit is immediately applied to your tax liability on your corporate tax return. This means that your benefit is calculated in your final tax due. If you file your return timely, you will not have to wait for the IRS to issue a refund. If you did make an amended claim, that claim can take anywhere between six (6) months to nine (9) months to be processed.

Why hasn't my CPA told me about the R&D Tax Credit?

CPAs are expected to have a general and broad knowledge of tax. This allows them to tackle the hundreds of possible situations that they deal with on a daily basis for their clients. Because the R&D tax credit, unlike other tax incentives, requires deep experience and interpretation of code sections that are not always clearly defined, it is not uncommon for CPAs to recommend consulting services or calculation platforms to handle the R&D credit while they handle everything else.

I don't have any employees; can I still claim the credit?

Yes, employee salaries are only one (1) of the qualified expenses that generate an R&D tax credit. Other qualified expenses include Supplies and Materials, Outside Contractors, and even Cloud Computing costs! Not having employees does not preclude a company from claiming and utilizing the R&D tax credit.

What happens if I get audited as a result of applying for the R&D Tax Credit?

In the case of an audit, provided you conducted your study, we would provide audit assistance, free of charge with your study. This includes direct discussions with our R&D tax credit experts who will advise you every step of the way and help you navigate the complex Internal Revenue Code to defend the credits you have generated.

How is the R&D Tax Credit computed?

There are two (2) different calculation methods for the R&D tax credit. The first is the Regular Credit which compares your current R&D qualified expenses to historic R&D spend by comparing past years spend against your total revenue. The second method is the Alternative Simplified Credit (ASC), which compares your current spend to the prior three (3) years of spend by your company. We run both methods to determine the maximum benefit that your company is entitled to.

What type of deliverable will I receive for the R&D Tax Credit?

We provide several items in its final deliverable for every study completed on the platform. This includes relevant tax forms (Form 6765, any state R&D tax credit forms) in addition to Qualified Research Expense (QRE) summaries for each category of expenses where QREs were identified. The level of detail within the expense analysis will be dependent on the detail provided during the study. Finally, there will be an informational guide with filing instructions.

What are the limitations on the R&D Tax Credit?

The Research and Development Tax Credit, like other general business credits, cannot exceed the excess of the taxpayer's "net income tax" over the greater of the tentative minimum tax for the year or 25% of the taxpayer's "net regular tax" that exceeds $25,000. Net income tax means the regular tax and alternative minimum tax less nonrefundable personal credits, foreign tax credits, and certain credits dealing with motor vehicles. Net regular tax means the regular tax less the same credits.

In addition, certain "eligible small businesses" may use the Research and Development Tax Credit to offset their alternative minimum tax. Eligible small businesses for this purpose are non-publicly traded corporations, partnerships, and sole proprietorships with less than $50 million in average gross receipts for the three preceding tax years. Credits for a partnership or S corporation are not allowed to a partner or shareholder unless the partner or shareholder meets the $50 million gross receipts limit for the year the credit is claimed.

Prior to the enactment of the PATH Act, many taxpayers also were unable to realize the benefits of the R&D tax credit in a given year due to the application of AMT liability, which the R&D tax credit could not reduce. Fortunately, the PATH Act also allows eligible small businesses (ESBs) to use the R&D credit to offset their AMT liability for tax years beginning after Dec. 31, 2015. (The legislation known as the Tax Cuts and Jobs Act, P.L. 115-97, repealed the AMT for C corporations for tax years 2018 and following and, for individuals in tax years 2018 through 2025, increased the AMT exemption amount and the exemption's phaseout threshold.)

Any unused portion of the credit may be carried back one year and forward 20 years. Any unused credit at the end of the 20-year carryover period may be deducted in the 21st year.

Can you take dedution under Section 174 and also claim the R &D Tax Credit

Sec. 280C(c) prevents a double benefit, denying any deduction under Sec. 174 by the amount of a credit claimed under Sec. 41 for the same expenditures. Alternatively, the taxpayer may elect to claim a reduced research tax credit in lieu of reducing otherwise allowable deductions.

Do I qualify for R&D Tax Credits?

If your business has less than $5 million in annual revenue, and it's been less than five (5) years since your first gross receipts/sales, you can frequently reduce your Social Security Payroll tax liability under the PATH Act R&D credit. If you do not qualify under the PATH Act R&D Credit, you can take regular R&D Credit against income taxes (rather than against payroll taxes).

As a tax or accounting or bookkeeping professional, am I able to refer your services and receive compensation?

Yes, join our Tax Credit Team and earn by offering these and other tax savings and credit to your clients

How much money can you recover from the R & D Tax Credit

There is no cap on the amount your business can claim in R&D tax credits. Since R&D tax credits are determined by the size and scale of your business’s technical activities — the more you spend, the more you save. Most businesses recover about 10% of their qualified R&D tax credit expenditures.

What examples of technical activities qualify for the R & D Tax Credit?

Qualifying R&D expenses and/or activities are those which pass this four-part test:

Technical uncertainty. The activity is performed to eliminate technical uncertainty about the development or improvement of a product or process, which includes computer software, techniques, formulas, and inventions.

Process of experimentation. The activities include some process of experimentation undertaken to eliminate or resolve a technical uncertainty. This process involves an evaluation of alternative solutions or approaches and is performed through modeling, simulation, systematic trial and error, or other methods.

Technological in nature. The process of experimentation relies on the hard sciences, such as engineering, physics, chemistry, biology, or computer science.

Qualified purpose. The purpose of the activity must be to create a new or improved product or process, including computer software, that results in increased performance, function, reliability, or quality.

Examples of technical activities that qualify for the R&D tax credit include:

• Developing Consumer Products
• Developing Software or Mobile Applications
• Developing New Processes or Techniques to Manufacture Products
• Improve the Performance, Functionality, Quality, or Reliability of Existing Products
• Designing Prototypes
• Testing Competitors’ Products
• Conducting Research that Speeds Up Your Time-to-Market
• Implementing New Process Automation
• Implementing Process Improvements that Reduce Waste or Improve Efficiency
• Developing Formula Improvements for Food, Beverage, or Chemical Applications
• Creating Patentable Products or Processes

How large will my R&D tax credit be?

Unlimited, if applying the R&D credit against income taxes. These credits can range between 5% and 15% of qualifying R&D costs. If taking the PATH Act R&D credit, a company can receive up to $500k* against payroll taxes and take the remainder against income taxes.

As an example, for an unprofitable 5-person tech startup that has less than $5M in annual revenue with roughly 80% of time being spent on qualifying R&D activities, and average salary of $100k/year, the credit might be between $20k to $60k. Tax Prep Advocates’ fee is a small percentage of the total qualifying R&D expense and easily pays for itself by securing the R&D Tax Credit for you.

*$500,000 for 2023 tax year, $250,000 for 2022 tax year

Can I claim the R&D credit retroactively?

Yes, we can help you file an amended tax return to claim the R&D credit for previously filed Income Tax returns (past 3 years), but you cannot take the PATH Act R&D credit on an amended tax return.

What does Legacy Tax & Resolution Services' R&D Credit Service include?

We help businesses with all aspects of claiming these R&D Tax Credits. Legacy Tax & Resolution Services will:

✓ Identify and calculate qualifying R&D expenses.

✓ Prepare Forms 6765, 8974, and 941 to gain IRS approval of credit. If you use Legacy Tax & Resolution Services as your tax professionals, we’ll file on your behalf as well.

✓ Prepare all required supporting technical and financial documentation, including documentation of research time, R&D payroll expenses, etc. This is an important pre-requisite to support an IRS audit in case that happens.

✓ Coordinate with your tax preparer, payroll provider, and accountant to ensure your books and taxes are accurate.

✓ Continually ensure the credit is applied correctly against your payroll liabilities.

✓ Email and phone support with R&D credit experts.

Does Legacy Tax & Resolution Services support you in case of an audit?

Yes, we can help support you in the case of an audit.

Why is having an R&D study done important?

Legacy Tax & Resolution Services recommends anyone who claims the R&D credit get a study done. An R&D study determines the total amount the business should claim and collects the necessary documentation to support that claim.

When filing for the R&D tax credit, you must submit the relevant tax forms to the IRS. However, you must also have the technical and financial justification of what you were claiming prepared in case the IRS audits your claim. If the IRS audits the claim and you can’t produce technical and financial evidence behind what you claimed, you will need to return the money and potentially pay a penalty.

Can I use Legacy Tax & Resolution Services' R&D Credit Service without using your Tax Preparation services?

Yes, we’ll calculate the R&D tax credits and provide the necessary documentation for your tax preparer to file. If you use Legacy Tax & Resolution Services as your tax professionals, we’ll take care of the full process and file the necessary tax paperwork on your behalf as well.

Are there state-level R&D tax credits?

41 states currently offer an R&D credit. Generally, the states follow federal guidelines on what constitutes qualified R&D expenditures with a few exceptions. Legacy Tax & Resolution Services will provide guidance on state level credits. For example, the CA R&D credit is non-refundable which means it cannot be taken against payroll tax. Work must be done in CA to be considered qualified and CA credits can carry forward indefinitely until exhausted.

Is it worth the time?

Absolutely! Considering the positive impact on your cash flows or bottom line and that your assessment can typically be completed in 90 minutes, this is the reason why this credit scores very well on something we call the “Good to Grief Ratio” which measures the value you receive vs. the time you have to put in to get that value.

Isn’t the R&D credit just for tech or scientific companies?

No. It’s for all types of companies, many that don’t even realize are eligible.

How is a credit different than a deduction?

Regarding tax deduction vs. tax credit, the essential difference between deduction and credit is that a credit directly decreases the amount of tax you owe while adeduction lowers your overall amount of taxable income. A nonrefundable credit lets you reduce your tax liability to 0.

Why does this government do this?

The government wants to keep innovation here in the United States by incentivizing companies to develop projects by reducing the financial risk on projects where cost might prevent them from pursuing them.

How do I know if I qualify for the R&D tax credit?

If your business invests in the innovation of a product or process, you may qualify for the R&D tax credits.  To see if your business qualifies, use the link below for a phone consultation to determine your project's eligibility.

How much will the R&D credit save my business in taxes?

Once you enter your business and R&D spending details into our system, you'll get an estimated saving for your business's potential savings.  After receiving your estimated savings, we will guide you through the documentation and steps to claim the credit.

Is the R&D tax credit legitimate?  It sounds too good to be true.

Yes, the R&D tax credits are legitimate and were created by the government of the United States to encourage technology-based innovation by providing tax credits.

Why should I take the R&D tax credit?

As with any tax credit, the R&D tax credits create funds that go back into your business's pocket to fuel additional innovation and grow your business's bottom line.

Where did the R&D Tax Credit come from?

The R&D tax credit was initially created in the 1980s by U.S. Representative Jack Kemp and U.S. Senator William Roth.  It has since expired eight times and been extended fifteen times.  It was created to protect Americans, encourage investment in development, and increase research activities along with basic research payments.  With the competitiveness of today's business world, Congress is encouraging businesses to increase their research activities; they do want to increase economic growth, after all.

In the past, the Alternative Minimum Tax (AMT) did prevent businesses from being able to file.  Then Congress passed the Tax Cuts and Jobs Act of 2017 (TCJA) which reduced the corporate tax rate, thus increasing the value of the R&D tax credit.

The Tax Cut and Jobs Act (TCJA) was created to help lower business tax rates.  They created the R&D tax credit and made it permanent while eliminating other corporate tax credits.  As a result of the TCJA, there were changes in tax deductions beginning at the end of December 2021.  Before the TCJA was created, companies had to reduce regular credit to 20% of Qualified Restoration Expenditures (QRE) to 13% of QRE spending or be forced to have reduced credit on alternative simplified credit.  If you're interested in learning more, the IRS has created specific guidelines for businesses to file for research and development tax credit in Internal Revenue Code (IRC) Section 41 and Section 174.

How do you qualify for the R&D Tax Credit?

Many businesses are not aware they meet eligibility qualifications.  Some believe there are special rules needed to qualify.  While the correct documentation is required, over 60 industries can qualify for R&D credit in over 30 states to offset tax liabilities.  Some businesses' daily operations can even qualify them, allowing them to receive basic research credit if it puts them over a certain base amount.  Even start-ups can use this to their advantage.

Here are some of the factors small businesses and large businesses alike must be doing to qualify:

What's the process like of claiming the R&D tax credits?

The first step is to find your estimated savings in our system in minutes.  Once you determine an estimate of savings, we guide you through every step, from determining the eligible projects and expenses to creating the documentation needed and preparing final documents for submission during tax season.

Do I need to be an R&D tax credit expert to use your system?

No, you do not.  We created our system with educational, step-by-step guides to make these lucrative tax credits accessible and affordable to any business, regardless of their prior experience working with R&D tax credits.  However, we recommend working with tax and accounting professionals to gain complete confidence in claiming your credit.

Our project failed, and we will not qualify.

Not true.  Tally the eligible costs up to the termination point and include those in your company's R&D credit calculation.

We don't quality because we have no federal tax liability.

Smaller businesses and start-up companies can apply their R&D credits against their payroll tax—not just their profits.

We're not engineers, drug researchers, or software developers, so we're not a good fit.

All types of companies in various industries are now successfully utilizing R&D credits.

Does the R&D credit apply to both direct and indirect research expenses?

No, the R&D tax credit may be claimed for direct research expenses only.

Direct research expenses are costs that are directly associated with the performance of qualified research, such as:

• Wages paid to employees who are directly involved in R&D activities;
• Supplies used in R&D activities; or
• Contract research expenses.

Indirect research expenses are costs that are associated with the performance of qualified research but cannot be directly linked to such research because they are merely tangential. A common example of an indirect research expense is overhead costs (such as rents and utilities).

What are qualified research expenses?

Qualified research expenses (QREs) are defined in §41(b)(1) of the Internal Revenue Code as the sum of in-house research expenses and contract research expenses.

In-house research expenses include:

• Wages paid to employees for the performance of qualified services (engaging in qualified research or the direct supervision or support of the research);
• Supplies used in the conduct of qualified research; and
• Fees paid to another person for the right to use a computer in the conduct of qualified research.

Contract research expenses include:

• Generally, 65% of any amount paid to a third party for the performance of qualified research; and
• Only allowable if the work conducted by the third-party contractor would be considered qualified if performed by an employee of the taxpayer

To be eligible for the R&D tax credit, the expenses must be for qualified research activities that meet specific requirements. The research must be technological in nature and involve a process of experimentation. It must be intended to be useful in developing a new or improved product, process, or technique. The research must also be conducted in the United States, and the expenses must be incurred in the tax year in which the credit is claimed. If an expense is not set forth in §41(b), it cannot be claimed as a QRE.

What is the consistency requirement for qualified research expenses?

The consistency requirement in §41(c)(5)(A) states that the qualified research expenses (QREs) and gross receipts used to compute the fixed base percentage for the R&D credit must be determined consistently with the determination of QREs for the credit year.

This means that the QREs in the credit year and during the base years must be consistent, along with the gross receipts in the base years and the prior four years' average.

This requirement is designed to accurately determine the increase in QREs relative to the taxpayer's gross receipts. If a taxpayer claims an expense as a QRE in the credit year that it did not previously treat as a QRE, it must adjust its fixed base percentage to include similar expenses paid or incurred during the base years. The research credit is an incremental credit, so the taxpayer must demonstrate that there has been an increase in QREs relative to the base period.

The consistency requirement applies even if the period for filing a claim for credit or refund has expired for any taxable year that is considered in determining the fixed base percentage.

What's the 4-part test for R&D credits?

To qualify for the R&D tax credit, the IRS requires taxpayers to satisfy a four-part test to demonstrate the activity permitted activities and expenses. This test is crucial because it sets the requirements for what "qualified research activities" can potentially qualify for R&D tax credits. This helps ensure that only eligible activities receive the incentive, and it guides companies on how to structure their R&D activities to maximize their chances of qualifying for the credit.

The four different parts of the test are:

• The Business Component Test
• The Section 174 Test
• The Process of Experimentation Test
• The Discovering Technological Information Test

Each test must be satisfied in order to qualify for the R&D tax credit. The requirements for each test are described below.

Does my employee have to be an engineer or scientist for their work to qualify for an R&D credit?

Not necessarily. Credit eligibility is based on what an employee actually does, or doesn’t do, during a specific time period. It’s important to note the technical and educational qualifications of a researcher, but this alone isn’t conclusive evidence of their work being qualified for an R&D credit.  

Companies with large numbers of engineers and scientists do stand out as prime candidates for the credit because it was created to encourage research and experimentation based on the "hard sciences."  Examples of hard sciences include physics, chemistry, and biology, while examples of soft sciences include sociology and psychology. 

But this holds true regardless of who performs the activities and can include employees with many different job titles and backgrounds. Experimentation performed by both employees and third-party contractors who engage in the improvement of projects and processes may be included.

What documentation is needed to substantiate payroll expenses for R&D credits?

To claim payroll expenses for R&D tax credits, you must provide supporting documentation to verify the wages and salaries you claim. In addition, you might need to provide documentation that shows that the employees whose wages and salaries you're claiming were directly involved in the qualified R&D activities.

Documentation for wages and salaries may include the following:

• Payroll records, like pay stubs and wage and earnings statements.
• Other records show the amount, date, and nature of the wages and salaries you're claiming.

To prove qualified research activities, you may need the following:

• Timesheets.
• Project plans.
• Other records show the specific tasks and activities the employees were involved in.
• Other records show how much time employees spent on specific activities.

In general, you should retain thorough and detailed records of your payroll expenses in case the IRS or other tax authorities need to verify your claims.

The specific documentation required can vary depending on the location and circumstances of your business. So, it's always a good idea to consult with a tax professional or refer to your area's relevant tax laws and regulations to determine the exact requirements.

Which documents do I need to support the R&D credit?

Below you'll find comprehensive documentation lists below for qualified research expenses (QREs) and R&D activities. Please remember that the lists aren't exhaustive since there can be variations depending on your specific type of business, the research conducted, and the types of expenses. Depending on your circumstances, you may need to provide more or less documentation.

For QREs:

General

• Calculations of your base amount and fixed base percentage
• Chart of accounts
• Acquisitions and dispositions from 1984 through the tax year under audit (if applicable)
• Accounting method ( i.e., whether costs are accumulated by department or by project).
  • The IRS's preferred method for capturing qualified research expenses is a project-based approach where you can create a solid connection between qualified research activities and qualified research expenses. Project-based accounting captures research costs at the "business component" level, whereas cost-center accounting doesn't always provide enough connection between qualified activities and their related costs.

Wages

• Organizational chart
• Names and work titles of the employees whose wages are included in the calculations for the credit.
• Position description, what each employee did, and the amount of their time and wages included in the credit.
• Timesheets
  • Tracking through a time-tracking system helps create a solid connection between wage-qualified research activities and qualified research expenses. Alternatively, you may rely on estimates through oral testimony or time allocation questionnaires.
• W2s
  • This excludes non-taxable items, such as 401(k) contributions, health insurance contributions, and other pre-tax benefit deductions.
• Any other documentation related to the R&D credit claim
• Breakdown of wages claimed by the employee, year, and qualified project.
• Payroll registers

Supplies

• List of the supplies showing they are tangible property, the corresponding amount, and invoices.
• Information on how the supplies were used concerning R&D activities.
• Chart of accounts
• General ledger
• Purchase orders
• Invoices

Note: You should develop a systematic protocol to track or allocate qualified supply expenses to applicable qualified business components.

Contracts

• Names, addresses, and the amount claimed for each contractor
• The location where the contractor conducted the claimed activities
• Description of the research activities performed
• Description of ownership relationships between the company claiming the credit and the contractor
• Contractual agreements and invoices
• Chart of accounts
• General ledger
• Purchase orders
• Form 1099 (for individual contractors)

Note: If possible, you should track or allocate contract research expenses to applicable qualified business components.

For R&D activities:

• Complete project lists identifying current and ongoing R&D projects claimed.
• Description of each business component's new or improved function, performance, reliability, or quality.
• Description of the process of experimentation.
  • In chronological order, of all the steps or activities undertaken when developing or improving a product or business component. For example, a timeline description of the company's development processes and procedures.
• Documentation showing the scope of the research activities, including the problem to solve, potential solutions, concerns, and project authorization requests.
• Procedure manual, project checklist, technical abstract, lab schedule, lab report, project status report, summary experiment data results, etc., for products or business components developed or improved and claimed for the research credit.
• Issue logs, meeting minutes, chronological timelines, internal memos, emails, patent applications, abstracts, work orders, budgets, capital addition requests, purchase orders, invoices, contractual agreements with customers, grants, etc., related to the research.
• Workpapers generated while calculating the credit
• Patents or patent applications
• Design requirements, functional specifications, modeling simulation documentation
• Testing scripts

What is the startup provision?

The startup provision allows companies to claim credits against payroll taxes if they’re not paying income tax. This is great for pre-revenue firms that are spending a lot on product development but haven’t gone to market yet. We can decrease your burn rate by getting you money back. You can claim up to 250k a year, and up to 1.25 million in total.

Is the payroll benefit only for startups or small businesses?

No. It just needs to have:

1. Gross receipts less than $5 million in the taxable credit year.
2. No gross receipts for any taxable year preceding the 5-taxable year period ending with the taxable credit year.
3. R&D payroll tax credit can use in that year.

So even companies that have been around for more than five years and have spent billions of dollars to develop or improve any component could be eligible.

Can I claim the R&D credit if I own a startup or small business?

Yes, a startup or small business may be able to claim the R&D credit if it is conducting qualified research activities in the United States. The business must have qualifying research expenses, which are generally defined as expenses incurred in the process of attempting to develop new or improved products, processes, techniques, formulas, inventions, or software. If a startup or small business meets these requirements and documents appropriately, it may be able to claim the R&D credit.

Here is a list of things that a small business should consider when documenting their R&D qualifying research activities and expenses:

Keep detailed records of research activities and expenses. 

Document how research activities and expenses relate to the company's business. 

Retain receipts, invoices, and other documentation for expenses. 

Maintain time logs or other documentation of time spent on qualified research activities by employees. 

Keep records of any prototypes or pilot models developed as part of the research process. 

Document the technical uncertainty being addressed through the research. 

Keep records of any outside contracts or collaborations related to the research. 

Maintain documentation of any failed research efforts.

Instead helps walk you through step by step how to determine if you are eligible for the credit and every step needed to implement the credit.

How do I claim a federal R&D credit?

To actually claim an R&D tax credit at the federal level in the US, you’ll need to complete and file Form 6765, “Credit for Increasing Research Activities,” with the IRS. It’s used to calculate the amount of the credit that you’re eligible to claim, and it has to be attached to your tax return

You will need the following:

Information on your eligible R&D expenses.

Info on any other relevant business and research activities. 

Attach supporting documentation to verify expenses, such as receipts and invoices. 

Once you have completed and filed the form, the IRS will review your claim and determine the amount of credit you’re eligible for. If approved, the credit will be applied to your tax liability for the current tax year, reducing the amount of taxes that you owe.

It’s important to note that the rules and regulations regarding R&D tax credits can vary depending on your location and the specific circumstances of your business. So, it’s always a good idea to consult with a tax professional or refer to the relevant tax laws and regulations in your area to ensure that you’re following the correct process.

How do the rules for the R&D credit differ depending on size or revenue?

The rules generally apply the same way to businesses regardless of size or revenue, but there may be some differences in how the credit is calculated and claimed depending on the revenue and age of the business. 

In general, the R&D credit is available to businesses of all sizes and industries that engage in qualified research activities, and the credit is calculated based on a percentage of the eligible research expenses incurred by the business. 

However, there are special rules that apply for qualified and eligible small businesses that relate to payroll taxes and the Alternative Minimum Tax (AMT).

For example, the R&D credit for small businesses (defined as those with gross receipts of less than $5 million and no more than five years of gross receipts) lets the business use the credit to offset the employer portion of payroll taxes instead of using it against income taxes. 

Additionally, the R&D credit may be subject to AMT rules, which can affect the amount of the credit that is available to certain businesses. Businesses that have less than $50 million in gross receipts can use the R&D credit when calculating their AMT liability while businesses larger than that may not.

Can I claim an R&D credit for research that was funded or sponsored by a government agency?

Typically, research funded by a government agency isn’t eligible for R&D credit unless an exception applies, which is made clear in the terms of the grant/subsidy. 

There are special rules and restrictions that apply when a taxpayer receives government funding for research activities.

First, the credit can’t be claimed for expenses for which you’ve received a grant, subsidy, or other forms of government funding unless the funding is specifically designated as not reducing the amount of the R&D credit.

In other words, if you receive funding from a government agency that is intended to offset the costs of your research activities, you can’t claim the R&D credit for the same expenses. This is because the government funding is considered a substitute for the R&D credit, and you can’t double-dip by claiming both the funding and the credit for the same expenses.

Second, even if you receive government funding that isn’t designated as reducing the R&D credit, you may still be subject to certain restrictions or limitations on the amount of the credit that can be claimed. For example, the R&D credit may be subject to alternative minimum tax (AMT) rules, which can affect the amount of the credit that’s available.

Finally, there are specific rules and guidelines dictating who can claim the credit when third-party funding is involved. To qualify for the credit, the business must bear the financial risk of the research and retain substantial rights, meaning that it has the right to use the intellectual property derived from the research in a way that isn’t limited by the third party. 

In situations where the agreement between the business and the third party is unclear, incomplete, or nonexistent, it may be necessary to conduct a funding analysis to determine the eligibility for the credit. This analysis may involve examining the agreements between the parties, referencing contract law, and evaluating court precedents. It’s important for businesses to carefully consider the rules and requirements for claiming the R&D tax credit in order to ensure compliance with the law and to maximize the potential benefits of the credit.

Can I claim an R&D credit for the same expenses as other tax incentives?

No. In general, the rules for the R&D credit allow you to claim the credit for qualified research expenses that aren’t otherwise deductible or recoverable. But, you may not claim the R&D credit for expenses for which you’ve received a grant, subsidy, or other forms of government funding unless the funding is specifically designated as not reducing the amount of the R&D credit. 

Additionally, you may not claim the R&D credit for expenses that are included in the basis of depreciable property, or for expenses for which you’ve claimed a deduction under another provision of the tax code, such as the domestic production activities deduction.

Can you utilize unused portions of R&D tax credits?

Yes, you may be able to carry forward (or carry back) the unused portion of the tax credit  in certain situations. 

The unused portion of the R&D tax credit may be carried forward for up to 20 years and there is not a limitation on how much can be claimed through this tax credit. 

If you believe you were previously eligible for the credit and failed to claim it, you can amend your business’s tax returns for three years (typically 4 years for state). If you had non-taxable or net loss tax years where the statute of limitations has closed, you may be able to go back additional years to calculate credits and carry them forward to taxable years on a carry-forward schedule for up to 20 years until utilized.

For example, if you have an R&D tax credit in a particular year that is larger than your tax liability for that year, you may be able to apply the unused portion of the credit against your tax liability in a future year, or to claim a refund for taxes paid in a previous year. 

How are R&D credits affected when the company is subject to alternative minimum tax (AMT)?

The alternative minimum tax (AMT) is a separate tax system that imposes a minimum tax on individuals and corporations that may have a lower tax liability under the regular tax system. The AMT is designed to ensure that individuals and corporations with higher income pay at least a minimum level of tax.

The R&D credit allowed for any tax year is subject to a limitation based on the taxpayer's tax liability. For non-corporate taxpayers, the credit may not exceed the excess of the taxpayer's net income tax over the greater of: (i) the taxpayer's tentative minimum tax for the tax year; or (ii) 25% of so much of the taxpayer's net regular tax liability as exceeds $25,000. For this purpose, the net income tax is generally the sum of the regular tax liability and the AMT, and the net regular tax liability is the regular tax liability. Tentative minimum tax is the AMT increased by the regular tax.

For corporations, the credit may not exceed the excess of the taxpayer's net income tax over 25% of the taxpayer's net income tax as it exceeds $25,000.

However, individuals, including those who have ownership in S corporations or partnerships or sole proprietors with average annual gross receipts over the prior three years of less than $50 million may reduce AMT and their overall tax liability by the R&D credit.

It's important to note that the AMT rules and how R&D credits are affected by the AMT can be complex and may vary depending on the specific circumstances of the company. It may be advisable to consult with a tax professional or refer to the Internal Revenue Service (IRS) guidelines for more information on how the AMT affects the R&D credit.

Can I still claim an R&D credit if my company isn't developing anything new?

Yes, you could still claim the credit despite not developing anything new, provided that you meet the criteria.

The Research and Development (R&D) tax credit is a program that allows eligible companies to claim a tax credit for certain expenses associated with conducting research and development activities. To be eligible for the credit, a company must be engaged in qualified research and development activities, which generally means activities that seek to create new or improved products, processes, or technologies. 

It would also have to pass the 4-part test for R&D credits to be eligible to claim the credit.

R&D tax credits are for taxpayers who design, develop, or improve products, processes, techniques, formulas, or software. It’s calculated on the basis of increases in research activities and expenditures—and as a result, it’s intended to reward companies that pursue innovation with increasing investment.

What are energy research consortia and do payments made to them qualify for a federal R&D tax credit?

Energy research consortia are groups of companies or organizations that collaborate on research and development projects related to energy. These consortia may be formed for a variety of reasons, including to pool resources and expertise to address complex problems, to share the costs of research and development, or to gain access to specialized facilities or equipment.

The IRC §41(a)(3) provides a 20% credit for payments made by a business to an energy research consortium for qualified energy research. This credit is a flat credit equal to 20% of the total qualifying expenditures, rather than the incremental increase in qualifying expenditures over a base amount. 

To qualify as an energy research consortium, an organization must be tax-exempt, focused on conducting energy research in the public interest, and not a private foundation. At least five unrelated persons must also contribute to the organization for energy research during the calendar year in which the organization's tax year begins, and no single person can contribute more than 50% of the total amounts received by the organization. 

Energy research does not include research that is not qualified under IRC §41(d). A business claiming the 20% credit for payments to a qualified energy research consortium may not also claim those same expenditures for purposes of determining the amount of contract research expenses eligible for other components of the research credit. However, if the business does not claim the credit for energy research consortium payments, 75% of those payments may be taken into account in determining the contract research expenses eligible for the other components of the research credit if the energy research consortium meets the definition of a "qualified research consortium."

Can companies more than 5 years old get the payroll benefit?

Yes. Although the law is intended to benefit small businesses, any company formed prior to 2012 that did not receive gross receipts could also potentially benefit.

What is the payroll credit election and how is it beneficial?

A special election exists if your business meets the standards to be considered a qualified small business (QSB). There are different definitions for a QSB depending on their business structure:

Corporations and partnerships

To be considered a QSB, the business must have gross receipts of less than $5 million and no gross receipts in any tax year before the five-tax-year period ending with the current tax year. 

Other businesses

A person who is not a corporation or partnership may also be considered a qualified small business if their aggregate gross receipts from all trades or businesses is less than $5 million and they had no gross receipts for any tax year before the five-tax-year period ending with the current tax year.

Tax-exempt organizations

Even if they satisfy the above requirements, organizations that are exempt from income tax under the Internal Revenue Code (IRC) §501 are never considered QSBs.

In addition to meeting the qualifications for a QSB, the business must also reach the regular standards for conducting and recording qualified research activities and expenses. If a startup or small business meets these requirements, it may be able to claim the R&D credit by electing to apply a portion of the credit against its payroll taxes rather than its income tax liability.

The amount of the credit used against the QSB’s payroll tax liability is limited to the lesser of:

The total research credit in the tax year,

Up to $500,000, or

The amount of the QSB’s business credit carry-forward (not applicable to partnerships or S corporations).

When do I claim the payroll tax offset?

The payroll tax offset is available on a quarterly basis beginning in the first calendar quarter that begins after a taxpayer files their federal income tax return.

What is the R&D payroll tax credit requirements?

The R&D payroll tax credit requirements vary by country and jurisdiction. It typically involves qualifying research and development activities and meeting specific criteria for eligible expenses and documentation.

What is the R&D shrink-back rule?

The shrink-back rule is a concept that is used when determining which expenses qualify for the R&D tax credit. 

When determining which expenses qualify as qualified research expenses (QREs), companies typically have to go through a four-part test. This test is used to determine whether the expenses are related to qualified research activities. However, it is a common misconception that if a project as a whole does not pass the four-part test, then the entire project is disqualified.

The shrink-back rule allows companies to take advantage of the four-part test even when a large-scale project, which may not be qualified, has smaller components that require significant improvements related to function, performance, reliability, or quality. The smaller “subproject” of a project can be used to meet the new or improved business component requirement part of the four-part test. The development costs of the subproject can then be qualified and included in QREs.

To make it simple, the shrink-back rule lets companies claim the R&D credit for expenses that are incurred on specific parts of large projects that otherwise may not qualify for the credit as a whole.

Can you sell R&D tax credits?

Federal R&D tax credits in the United States are not saleable or transferable. The credits are directly tied to the company that incurs the qualifying R&D expenses. They are not a separate asset that can be detached from the company and sold or transferred independently.

However, it's important to note that in situations where a company is sold or merged with another entity, the associated tax credits can potentially contribute to the overall value transferred in the transaction. Still, this is not the same as selling the credits separately.

There are no known exceptions to this rule at the federal level. The aim of the R&D tax credit program is to incentivize companies to invest in their own innovation and growth. Allowing the sale or transfer of these credits could potentially disrupt this incentive structure. Therefore, the IRS has clear rules against the selling or transferring of federal R&D tax credits.

We don't maintain supporting documentation of our R&D or track our employees' daily R&D activities.

If you can provide test reports, drawings or blueprints, value stream maps, project review presentations, financial records, and invoices for qualified expenses, your chances of qualifying may be good.

How much does an R & D Tax Credit study cost?

We don't charge our clients unless we find a benefit. If the client continues with the tax credit study, we charge a flat fee to determine by a percentage of the benefit we identify.  Additionally, if our clients are not satisfied with their cedit estimate after Phase 1 of our process, they may walk away without paying for services rendered during the Value Identification portion of the Tax Credit Study.

Why haven't I heard of the R & D Tax Credit?

The R&D credit is among the most misunderstood tax incentives available. Considering the myriad of industries and activities legally qualifying for the credit, the term "research and development" is a misnomer. The R & D Tax Credit also requires specialized knowledge and technology to identify and calculate the incentive property. It is really no wonder you have not heard of it.

Which industries qualify for the R & D Tax Credit?

Companies of various industries are unaware they can claim the R & D Tax Credit. Our specialists have successfully identified and delivered tax benefits to the following industries;

Aerospace

Agriculture

Architecture

Appeal

Brewing

Building System Controls

Chemical

Construction

Electronics

Energy

Engineering

Fabrication

Food and Beverage

Job Shops

Manufacturing

Medical Devices

MEP Contractors

Package Design

Pharmaceuticals

Plastic Injection Molding

Technology

Telecommunications

Tool and Die

Waste Management

Wineries

How many years can I go back to claim the R & D Tax Credit?

The R&D tax can be claimed for all open tax years.  Generally, open taxes years include the prior three tax years due to the statute of limitations period.  In certain circumstances, the law allows businesses to claim the R&D Tax Credit for an extended period.  It is common for companies to amend previous tax years to claim this benefit and reduce the maximum amount of tax liability.

How long does an R&D Tax Credit study take?

Each tax credit study is tailored to ensure that Legacy Tax & Resolution Services can analyze the required information and perform the necessary calculations to meet the needs of each client.  A typical tax credit study lasts about six weeks; however, in the event of a pressing deadline, LTRS can complete a study in as little as one week.

Where do I file the R&D Tax Credit?

Partnerships and S Corporations must file this form to claim the credit.  The credit will flow from Form 6765 to the K-1 to Form 3800 on the owner's personal tax return.

How do individuals claim this credit on their tax returns?

Individuals claiming this credit can report the credit directly on Form 3800, General Business Credit if their only source for the credit is a Partnership, S Corporation, Estate, or Trust.  Otherwise, Form 6765 must be filed with the individual's tax return (i.e., sole proprietorship).

Is there a limit to how much credit can be used in a given year?

For the years before 2016, the credit can be used to reduce the taxpayer's regular tax liability to the tentative minimum tax.  Beginning in the tax year 2016, eligible small businesses have expanded utilization for the credit,  For these eligible small businesses, the regular tax liability can offset alternative minimum tax using the "25/25" rule.  The credit cannot be used to offset alternative minimum tax.

It's normal to have questions when filing for Research and Development, also known as the research and experimentation tax credit, especially when tax hikes are in full swing.  Frequently businesses will file with incorrect documentation.  We would happily provide you with a documentation checklist if you have any questions regarding the correct documentation.

Partnering with Legacy Tax & Resolution Services (LTRS) is essential when filing for the R&D tax credit to ensure all is done to keep you in compliance and maximize your overall return – and that's why we're here!  We'll look at your expenditures, base amount, tax rate, contract research, and gross receipts in all open tax years to determine how much credit you qualify for so that your business can receive its basic research credit.  All records are kept for our internal use only.

Contact us today to learn how we can set your business up for success when filing for the R&D credit.

What if I have questions about the R&D credits throughout the process?

We expect you to have questions along the way!  That's why we've built our system as a guided platform that educates you as you move through the process of claiming R&D tax credits.

If your questions aren't answered directly inside the platform, you can always access our team via live chat and/or browse our self-serve knowledgebase of 200+ articles.  Additionally, our R&D Pros are ready to answer any questions.

Our R&D Pros are accountants, tax professionals, EAs, CPAs, and R&D consultants who can assist you in claiming your R&D tax credits.

What happens when you get audited for the R&D tax credit?

If you are audited for the research and development (R&D) credit, the Internal Revenue Service (IRS) will review your claim to ensure that you are eligible for the credit and that you have calculated the credit accurately. The audit process may involve the IRS requesting additional documentation or information to support your claim, as well as reviewing your financial records and other relevant documentation.

During the audit, the IRS will examine whether your research activities meet the criteria for qualified research, whether you have properly documented your research activities and expenses, and whether you have calculated the credit correctly. If the IRS determines that you are eligible for the R&D tax credit, it will allow the credit and any associated tax benefits. If the IRS determines that you are not eligible for the credit or that you have calculated the credit incorrectly, it may disallow the credit and assess any additional taxes and penalties that may be applicable.

It is important to carefully document and accurately calculate your R&D tax credit claim to avoid any issues during an audit. It is also advisable to consult with a tax professional or an experienced R&D tax credit specialist to ensure that your claim is properly prepared and supported.

How is the R & D Tax Credit monetized?

The R&D tax credit is generally used to offset federal income taxes. If the credit is not fully utilized the year it is generated, businesses may carry it back one year for a tax refund. If excess credit is still available, companies may carry it forward for up to 20 years. Startups that are not yet profitable may apply the credit toward federal payroll taxes to offset up to $500,000 each year for up to five years (a total of $2.5 million).

What is the fee for using Legacy Tax & Resolution Services' R&D Credit Service?

We charge 25% of your total credit received.

How is Legacy Tax & Resolutions Services different than other R&D tax credit services?

Legacy Tax & Resolution Services is the first solution that allows taxpayers, accountants, and their tax advisors to collaborate on claiming R&D credits by helping you determine project eligibility, estimate tax savings, and create the required documentation all in one affordable and accessible platform.