Research and Development (New Product) Tax Credit (R&D) Service

Demystifying R&D Tax Credits: How to Maximize Your Returns

Check Out This Explainer Video

Once you have finished watching the video, just hit the back arrow and it will take you back here.

If the Credit was known as the "New Product to Your Business" and/or "New Formula to Your Business" and/or "New Process to Your Business" and/or " New Invention for Your Business and/or "New Software Developed For Your Business" and/or "New Technique for Your Business" the R&D Credit Utilization Would Increase Significantly!

A couple of key points:

It does not have to be a new product, formula, process, invention, software, or technique to the industry or the world, it just has to be new to your business.

It just has to be a product, formula, process, invention, software, or technique to ANY BUSINESS, not just a tech company.

Why is this such an underutilized program? Well a lot has to do with the name of the credit program "Research and Development Tax Credit" program. Unfortunately, many companies still believe it is only eligible for big technology and science companies. Nothing could be further from the truth!

Some R&D Statistics

Approximately 33% of U.S. businesses qualify for the Research & Development (R&D) tax credit under current law. This credit applies to a wide range of industries, not just tech or manufacturing. Any business engaged in activities like improving products, processes, software, or formulas may qualify, as long as they are developing or improving something in a way that involves technical uncertainty and experimentation.

Many businesses miss out because they aren't aware that what they do qualifies for these tax incentives, but the credit is available to businesses of all sizes, including startups. The eligibility is broad, covering industries like agriculture, food production, construction, and even small businesses in areas like software development and engineering.

A survey conducted by Binder Dijker Otte (BDO), an international network of public accounting, tax, consulting and business advisory firms, in 2017 found that about 50% of surveyed firms who did not claim the R&D credit failed to do so because their company was not specifically focused on research and development . It is important to note that a business's research does not have to be big or successful in order to qualify for the credit.

We have found many of our clients regard their own daily efforts to make new and improved products or processes as “just doing my job,” when in fact they have been performing R&D qualifying activities all along. If your company develops, designs, and enhances products or processes, your business likely qualifies for the R&D Tax Credit. Below are some resent case studies;

MANUFACTURER E-COMMERCE

Annual Revenue: 63.1 Million Annual Revenue: 31 Million

Results Results

1 Million in Federal & State 2.2 Million in Federal & State

R & D Tax Credits R & D Tax Credits

APPAREL RETAIL SALES

Annual Revenue: 1 Billion Annual Revenue: 20 Million

Results Results

5 Million in Federal & State 1.3 Million in Federal & State

R & D Tax Credits R & D Tax Credits

PUBLIC PROGRAM STARTUP COMPANY

Annual Revenue: 60 Million Annual Revenue: Pre-Revenue

Results Results

2.5 Million in Federal & State 250K in Federal & State

R & D Tax Credits R & D Tax Credits

MARKETING AGENCY SAS

Annual Revenue: 20 Million Annual Revenue: 3 Million

Results Results

500K in Federal & State 375K in Federal & State

R & D Tax Credits R & D Tax Credits

$15 billion in tax savings is achieved annually by U.S. businesses claiming the credit, data from the National Science Foundation indicate that another $85 billion unclaimed R&D tax credits are untapped.

The federal Research & Development (R&D) tax credit is one of the most advantageous but underutilized incentives available to small and mid-sized businesses.

Originally introduced as a temporary measure in the Economic Recovery Tax Act of 1981 (ERTA), it has remained part of the tax code ever since benefiting thousands of companies in diverse industries. Yet, many more do not take advantage of the credit’s potentially significant benefits.

Tax Credit Highlights

✓ Increased Cash Flow: Unlock additional capital that can be reinvested into your business.

✓ Dollar-for-Dollar Tax Reduction: Benefit from federal and, in some instances, state tax reductions that directly lower your income tax.

✓ Retroactive Claims: You can claim credits for open tax years going back 3-4 years, providing an immediate financial boost.

✓ Reduced Tax Rate: Lower your overall tax rate, enabling greater profitability in the long run.

*Current Maximum Yearly Tax Credit Limits

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

Your Partner in R&D Tax Credits

As a leader in research and development tax incentives, Legacy Tax & Resolution Services recognizes that the steps you take today can impact the outcome of current and upcoming audits. Our licensed, experienced CPAs, EAs and Attorneys serving as an extension of your team.

Not only can our tax professionals identify R&D tax credit opportunities, but we'll also develop a customized analysis and documentation approach to maintain your eligibility for program participation going forward.

How does the Federal R&D tax credit work?

Typically, 6% to 8% of a company’s annual qualifying R&D expenses can be applied, dollar for dollar, against its federal income tax liability.

How does the State R&D tax credit work?

Depending on the state where the R&D activities are performed, companies can recover up to 12% of their expenses to offset various tax liabilities.

What qualifies as Research and Development?

Activities that generally qualify for the R&D credit have to meet the IRS’s four-part test:

1. Permitted purpose

The activity must be related to developing or improving the functionality, quality, reliability or performance of a business component (i.e. product, process, software, technique, formula or invention).

2. Technological in nature

The business component’s development must be based on a hard science, such as engineering, physics and chemistry, or the life, biological or computer sciences.

3. Elimination of uncertainty

From the outset, the organization must have faced technological uncertainty when designing or developing the business component.

4. Process of experimentation

The company must have evaluated multiple design alternatives or employed a systematic trial and error approach to overcome the technological uncertainties.

Which Companies Qualify?

Companies of any size that perform qualified activities are eligible for R&D tax credits

Which Activities Qualify?

The following sample activities qualify for the R&D tax credits:

Creating improved products, processes, formulas, software, and techniques
Automating or improving internal manufacturing processes
Designing tools, jigs, fixtures, and molds
Integrating new equipment
Development of software and firmware
Mobile application development
Internet of Things (IT) development
Development of data center, big data, and data mining tools
Integration of APIs and other technologies
Manufacturing new or improved products
Developing prototypes, first articles, models
Evaluation of alternative materials
Development of firmware
Network hardware and software development and optimization
Developing simulators

Which Industries Typically Qualify?

Aerospace
Tool & Die
Metal Fabrication
Plastics/Injection Molding
Consumer Products
Manufacturing
Architecture & Engineering
Food & Beverage
Financial Services
Mortgage & Banking
Construction/MEP
Software Development
Chemical
Contract Manufacturing
Pharma
Oil and Gas
Blockchain Development
Game Development
Any industry that develops or improves processes or products

Not all activities qualify for this credit, and understanding these exclusions is crucial in understanding the maximize their claims without overstepping boundaries. Here’s a brief overview of what doesn’t qualify:

Routine Data Collection: If a business is merely collecting data without seeking to resolve any uncertainty or without a process of experimentation, it won’t qualify. R&D needs to break new ground in some way.
Market Research: Activities such as market studies or sales promotions don’t make the cut. The focus here is more on boosting sales rather than innovation.
Non-Technical Changes: Superficial or aesthetic modifications that don’t fundamentally change how something works aren’t eligible. It’s about the science or technology involved!
Funded Research: If the research is funded by a client or any third party (where the funder retains rights to the results), it generally disqualifies from claiming the credit. The risk needs to be on the company performing the R&D.

Side note: you can be paid for your research and still claim the R&D tax credit. The devil is in the details concerns with how you are paid. Typically, if you are paid on a lump sum basis or your fee is contingent upon your work or research being successful, then the research is not funded.

Social Sciences: Projects centered around social sciences, arts, or humanities (like economics, business studies, etc.) do not qualify. We’re looking at scientific or technological advancements here.

Understanding these exclusions helps in ensuring that you only claim what truly qualifies, avoiding any pitfalls or audits down the line. It’s all about staying informed and proactive!

How far back can you claim R&D tax credits?

Businesses can claim the R&D credit retroactively by filing amended returns for any open tax years, which in most cases, is three years. The time frame may be longer, however, if the organization endured losses during that period.

Is R&D tax credit taxable income?

The R&D credit reduces federal taxable income, meaning that businesses receive a dollar-for-dollar tax credit and still gets to deduct expenses related to research and development.

Do R&D tax credits expire?

The Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently extended the R&D credits available under Section 41 of the Internal Revenue Code. If there is a lack of tax liability, business may carry unused credits forward for up to 20 years.

Note: The Refund statute is three years, meaning a company typically has three years (four for many state refunds) before the statute on the refund expires. After that, that's it-- You walked away from the refund forever! Remember, a company still has the option to carry forward, 20 years, but not OUT of a CLOSED YEAR(s). This statement concerns companies that qualified for past years.

Common Misconceptions on R&D Tax Credit

Many eligible small businesses are missing out on the innovation tax credit program. Here are some of the many reasons why eligible small companies do not think they are eligible for research and development tax programs.

There should be a catch.

Many entrepreneurs think the program sounds too good to be true, thus they do not pursue extra information about any benefits. Tax resolution services work with small and middle-sized business owners to discuss the logistics and needs of the plan, answer all their questions and give them education on how to become eligible for it. They make the collection of the benefits and offer all supporting documentation a very simple process.

We have not earned any revenue yet.

Companies do not possess the required revenue to qualify for the credit. Eligible small companies and startups can choose to take the benefit in the form of a payroll tax offset, claiming up to $250,000 until tax years beginning after January 1, 2023 — then it will be up to $500,000. For the startups to become eligible, the gross receipts should be less than $5 million in the year of the credit, with no gross receipts for any of the tax year that precedes the five-year tax period. This means that even if pre-revenue startups can become eligible for this program.

We have not hired any employees.

While wages in general contribute heavily to the final credit calculation, other costs such as supply expenses and payments of contractors are also eligible for it. The important thing is, when you take the research and development credit as a payroll tax offset without the real payroll, you can carry the credit forward till 20 years. This implies that after hiring employees and incurring the payroll taxes in five years of business, the credit is still applied.

My company is not a scientific

Thinking that you should have a lab or science or technology organization to qualify for the R&D tax credit is one of the major reasons why companies often fail to file for the benefit. The fact is that eligible research costs span many industries and can involve expenses related to both experiment-based and software development activities, to name some of the examples. You do not have to be the first company to development of new product or process. So, as long as you have made attempts to enhance or develop something that your company has not attempted before, your costs might qualify. Tax resolution services often do partnerships with entrepreneurs across the 40 eligible industries to assist in recognizing eligible operations they are already doing.

R&D Operations were not successful

With tax resolution service provider, one of the important components of the R&D tax program is companies do not have to become successful or integrate their work into a viable end product to qualify for the benefit. Risky initiatives often fail without any return on investment. Identifying that, the federal government offers incentives such as R&D credit to decrease the burden. As a result, you are rewarded for facing technical difficulties and pushing forward on inventive solutions. These technological breakthroughs are an important part of the research and development terrain. Even though work is not successful, the effort itself might qualify.

What documentation will I need to provide?

We’ll work with you to surface all the appropriate documentation to provide a comprehensive report of your qualified R&D tax credits.

Tax Returns
Financial Statements
Employee Payroll
Expense Records
Project Lists
Supporting Documentation

These elements will help us to develop a list of expenses related to the development of..

Inventions
Processes
New/Improved Products
Software
Formulations
Techniques

Additional State R&D Credits are currently available in the following states:

While some other states may eventually have State R&D Credits, they are not currently available in the following states:

Note: Just because a particular state does not have a program, does not mean it is not available on the federal return!

Here’s how we streamline the entire process:

We conduct an R&D tax study, which identifies the total amount of qualifying R&D expenses you can claim on its federal tax return.

We prepare and file the necessary tax paperwork to claim the R&D credit, we provide the right documentation for your tax preparer to file.

We provide required supporting documentation, which is an important prerequisite in case of an IRS audit.

With Legacy Tax & Resolution Services we can offer bookkeeping, tax return, accounting, and R&D credit support all under one roof. We already know your numbers from the ground up. That means we work fast and efficiently to identify expenses and maximize your savings.

Research & Development Tax Credit for Startups

The Protecting Americans from Tax Hikes (PATH) Act of 2015 introduced new, game-changing legislation for eligible small businesses, expanding the potential R&D benefit to businesses in start-up mode that are not paying income taxes yet. Historically, businesses could only use R&D tax credits to offset income taxes, which generally excluded pre-revenue startups. With this new provision, these pre-revenue startups now qualify. Too few payroll startups are taking advantage of these significant benefits because they do not believe that they qualify.

Startups often miss out on R&D tax credits due to the assumption they haven't grown or grossed enough to qualify. Effective January 2016, qualified small startup businesses can use the Research and Development Tax Credits to offset the FICA employer portion of the startup payroll taxes, annually, up to $500,000. This new component of the federal research and development tax credit was enacted to directly support startups that are not paying income taxes yet.

Research & Development Tax Credit for Established Businesses

In the United States, the R&D tax credit serves as an incentive for businesses to engage in innovation and technological advancements. There are both federal and state R&D credits. There are different components of the federal R&D credit, each with its own rules and benefits. Here's an overview of the four main types:

Regular/Standard R&D Credit Method: Also known as the Traditional Credit or the Internal Revenue Code (IRC) §41 Credit, this method calculates the credit based on a fixed base percentage. The percentage is determined by considering a company's qualified research expenses (QREs) and gross receipts in previous years, typically between 1984 and 1988. The credit is generally equal to 20% of the excess of the current year's QREs over a base amount, which is a product of the fixed base percentage and average annual gross receipts during the four preceding years.

Alternative Simplified Credit (ASC) Method: The ASC is designed to simplify the calculation process and make the R&D credit more accessible for businesses that do not have detailed records from the 1980s. The ASC calculates the credit based on the increase in R&D expenses over the average from the preceding three years. The credit is equal to 14% of the excess of the current year's QREs over 50% of the average QREs for the three preceding tax years.

R&D Energy Credit: This component of the R&D credit is related to contributions or payments made to third-party organizations that conduct energy research. To qualify for the energy credit, businesses must adhere to stringent and specific rules and requirements regarding the organizations that can receive these contributions. The credit is generally equal to 20% of the qualified research payments made to energy research consortiums during the tax year.

Basic Research Credit: Available only for C corporations, the basic research credit is related to contributions or payments made to third-party organizations that conduct scientific research. Specific rules and requirements determine which organizations qualify to receive these contributions. The credit is generally equal to 20% of the excess of the qualified research payments made to universities and other qualified organizations during the tax year over a base amount.

What is research and development?

Research and development, also known as R&D, is the process by which a company works to generate new knowledge that it might use to create new technology, products, services, or systems that it will either use or sell.

Many people think of pharmaceutical and technology companies when they hear "R&D." Still, other firms, including those producing consumer products, also invest time and resources into R&D.

Any business that create and sells a product or service, whether software or spark plugs, invests in some level of R&D.

Basic vs. Applied Research

Research and development comes in two main types: basic and applied.

Basic Research

Basic research (also known as fundamental research) focuses on improving our understanding of a particular problem or phenomenon by exploring big questions. Some examples of basic research questions are:

Why do mice get caught in traps?
Why are some people allergic to gluten?

While basic research can certainly help a company acquire new knowledge, its focus on research for its own sake means that the financial benefits are uncertain. Consequently, large corporations, universities, and government agencies primarily perform this type of research and development.

Applied Research

Applied research is also done to acquire knowledge. But unlike basic research, it's done with a specific goal, use, or product in mind. Where basic research is theoretical, applied research is practical, focusing on finding workable solutions for current problems. Some examples of applied research questions include:

How can we build a better mousetrap?
What combination of flours will produce the best gluten-free pie crust?

R&D is typically done to effect different outcomes as follows:

New Product Research and Development

R&D and product development often go hand in hand. Rapid changes in consumer demands and emerging technologies mean there's always a need to adapt. Before developing new products, you need a deep understanding of the market and the user needs. This lays the groundwork for the development of the new product.

Various concepts are generated and tested at the outset. These can then be prototyped for further research and testing.

Improving Existing Products and Processes

The continual evaluation of existing products, services, and processes is also a crucial part of R&D. If a product, service, or process is no longer profitable or adding value in a market, it risks stagnating.

It could also be that technology has been developed to facilitate improvements that may cut costs, make efficiency gains or improve safety. This can include improvements to the manufacturing and production processes of the product.

Legislative changes or shifts in user wants can also mean a product or process must change or evolve to remain viable.

What sectors does R&D occur in the most?

Research and development occurs across various sectors and industries and in companies of all sizes. These range from intensive R&D industries that rely heavily on R&D projects like pharmaceuticals, life sciences, automotive, software, and technology to areas like food and drink. R&D also plays a significant role in the construction industry, particularly manufacturing and engineering.

Businesses may have two option when it comes to calculating the federal research and development (R&D) tax credit. Depending on the circumstances, they may be able to use either the Regular Research Credit (RRC) Method or the alternative simplified credit (ASC) method.

What is the regular research credit calculation (RRC) method for the R&D tax credit?

The RRC method allows for a credit of 20% of a company's current year Qualified Research Expenses (QREs) over a base amount. This approach can be complicated because to calculate the credit, businesses need the average, annual gross R&D receipts over the prior four tax years and if they began operations in the 1980s or prior, they must gather data from some of those years.

What is the alternative simplified credit (ASC) method?

Unlike the RRC method, the ASC method doesn't require gross receipts as a component of the R&D tax credit calculation. Instead, it looks at QREs over the previous three-year period. This allows companies that lack the historical records necessary to document their base amount to determine their eligibility and file for the R&D tax credit. Under certain scenarios, the ASC may even allow businesses that are ineligible under the regular credit method to qualify for the R&D tax credit.

How do you calculate the R&D tax credit using the alternative simplified credit method?

As of 2009, the ASC is defined as 14% of QREs incurred in the current tax year, above 50% of the average QREs in the previous three years. If the taxpayer had no QREs during any of those three prior years, the credit is calculated as 6% of the QREs in the current tax year.

Using these guidelines, the four-step simplified calculation process is as follows:

Identify and calculate the average QREs for the prior three years
Multiply average QREs for that three year period by 50%
Subtract half of the three-year average (Step 2) from current year QREs
Multiply the result of Step 3 by 14%

For example, in Step One, a company has identified the following qualified historical research expenses:

2019 $50,000

2020 $110,000

2021 $120,000

2022 $130,000

2023 (Current Year) $140,000

The average QRE for the prior three-year period (2020- 2022) would be $360,000/3=$120,000.

In Step Two, the company determines half of this amount or $60,000.

In Step Three, the company takes its current year QRE amount of $140,000 and subtracts the $60,000 three-year average for a total of $80,000.

In Step Four, the company calculates its ASC by multiplying $80,000 by 14%, for a credit of $11,200.

ASC Method Summary

Three-year average QREs (2020-22) $120,000

Half of the three-year average $60,000

Current QRE-three-year average $80,000

Credit: $80,000 x 14% $11,200

When should a company choose the ASC vs. the RRC R&D calculation method?

In certain circumstances, such as a decline in R&D spending, companies may no longer qualify for the R&D tax credit using the RRC method. This doesn't mean, however, that they are entirely excluded because the ASC may still be an option.

For example, if a company's R&D efforts become more efficient and, therefore, less costly, it can negatively impact the ratio of its R&D spending relative to its gross receipts. The business may then fail to meet the requirements set in the "base period" under the terms of the law and be ineligible for the credit under the regular method.

Generally, a business should consider both the RRC and ASC options and when either potentially applies, calculate the credit using each methodology to determine which is most beneficial.

How do the RRC and ASC R&D tax credit calculation methods compare?

Compared to the ASC, the RRC R&D tax credit calculation may result in a larger credit under some scenarios, particularly those where the base amount is low. Other optimal circumstances for using this method occur when the business is a startup or its R&D expenditures are relatively recent. Note, however, that the RRC calculation is more complex than the ASC and often requires a great deal of effort to gather the requisite data – a task that some businesses are unable to do.

Now, let's compare our sample ASC calculation from earlier with the RRC method calculation using the additional details below:

Current Year QREs $140,000

Fixed base percentage 3%

Average annual QRE gross receipts over four years $250,000

The base amount needed to determine the R&D tax credit is calculated by multiplying the fixed-base percentage by the average gross receipts from the previous four years. This result, in this case, is $7,500.

Base amount $7,500

Greater of base amount or 50% current QREs $70,000

Excess of current QREs over minimum base amount $70,000

X 20% regular credit Calculation Rate $14,000

Based on these figures, the RRC method vs. the ASC qualified tax credit amount would be as follows:

RRC R&D Tax Credit Calculation ASC R&D Tax Credit Calculation

$14,000 vs. $11,200

The above example highly oversimplifies the calculation and the process of claiming the credit.

How can Legacy Tax & Resolution Service (LTRS) help determine R&D tax credit eligibility and filing?

With an unmatched combination of tax credit experience, technology and resources, LTRS makes claiming R&D tax credits as simple, streamlined and predictable as possible. We assist CPAs and their clients with financial inquiries and help them strategize the most effective ways to utilize tax credits. In addition, LTRS continuously monitors for changes in legislation and compliance requirements at the federal, state and local levels that may affect tax credits.

Who We Help

Put the Section 41 Research & Development tax credit program to work for your business, your clients, or your customers.

R&D Tax Credit Services for CPA Firms & Tax Professionals

Include R&D tax credit services in your client offerings to minimize tax risk and increase profit margins

Protect Your Clients' Bottom Line

Extend your service offerings beyond traditional CPA and tax firm capabilities to help your clients optimize return on investment

R&D Tax Credit Services for Financial Service Firms

Big picture tax and financial insight that maintains compliance and drives business value

Increase Working Capital

Leverage Legacy's Consulting's team of innovation tax professionals to develop customized solutions for clients that help them achieve their financial and professional goals.

R&D Tax Credit Services for Business Owners

Protect your profits and drive cash flow to your bottom line

Maximize Business ROI

Tap into the dollar-for-dollar savings power offered by the research and development tax credit to optimize your return on overall investment

WHY LEGACY TAX & RESOLUTION SERVICES?

Dedicated To R&D

No need to be the guinea pig for your CPA or other tax professional. We average 10-20% more funding than a CPA or other tax professional, not familiar with the nuances of the R&D program. Our success rate is nearly 98%, meaning if we provide you an estimate of the projected credit, 98% of the time that is exactly what you will receive.

R&D Program Specialists

Our team R&D Department strictly focuses on R&D, allowing us to be the experts and resulting in more funding for your business. This includes the supporting calculations and documentation required to be submitted with each application to the IRS. See below what makes our application package different.

Audit Protection Included

If you get audited, we will supply all criteria and assist in responding to the IRS.

Lightning Fast Results

Our proprietary process allows for faster results, which means faster funding. We have perfected the communication process with our stakeholders to work a case from initial submission through application submission with the IRS.

Maximum Funding

We evaluate your claim in every way possible to ensure we maximize your credit.

Professional Support

Although our process is quick and painless, we have answers with a dedicated team of ERC support specialists when you have questions.

What Your Business Can Expect, Using Our Services to Process Your R&D Application

Because of the aggressive and inaccurate claims made by "R&D Mills," the IRS has issued several warnings about ensuring that your R&D credits can be verified. The IRS demands detailed documentation and proof of compliance, including tax aggregation and attribution rules. Businesses and organizations must know the issues and take the necessary precautions to ensure their R&D claims are valid.

With so much on the line, attempting to complete a fully supported application on your own can be overwhelming. That's where Legacy Tax & Resolution Services comes in. Our experts help you navigate the complex world of Research and Development Tax Credits and deliver audit-ready reports that will give you confidence in your R&D Credit Application. Regarding the R&D Application Package submitted to the IRS, we believe in providing a package that will make the job of reviewing your case and reaching an approval decision by the IRS Agent fast and efficient. By providing an audit-ready R&D application, we accomplish three objects, 1) Because your application has been pre-audited, the application is ready for a quicker approval by the IRS reviewer 2) Your chances of being selected for a post-approval audit is considerably reduced because of our pre-audit process, 3) While no company can completely prevent a random audit, should you be selected, you know that your company is ready.

Below is what we provide

Audit Ready Report with Submission – Our Research Team builds a solid qualification case for every client. They create timelines and arguments to prove your qualifications for the R&D. Our audit-ready reports include all of the memos, write-ups, qualification summaries, and employee support necessary to assist the IRS agent in verifying your R &D claim and sustaining your claim in the event of an audit.
Qualification Criteria – Exactly how the business qualifies (ASC or RRC) is laid out in considerable detail as if we were preparing for an audit.
How Statutory Requirements Were Addressed – Taking into consideration Tax Aggregation and Attribution rules
Qualified Wage Details – Break down payroll information by employee per quarter, including eliminating any majority owners and those related to the majority owner by Attribution Rules. Take into consideration the employer size test and the allowable qualifying wages.
4 Part Qualification Test- We spend an extensive amount of time gathering information from the client to provide a pre-audit application package for submission to the IRS.

Preparation of Forms

The R&D tax claim needs to be submitted along with your annual entity or personal tax filing. Here is what you need to file:

Form 6765, Credit for Increasing Research Activities.
Form 3800, General Business Credit. This form has a line that asks for the amount of Credit for Increasing Research Activities.
Each state will have its own form if it offers a state R&D tax credit program. If you qualify for the payroll tax offset, you will need to make sure you account for it on Form 941, Employer’s Quarterly Federal Tax Return. You will also need to fill out and attach Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities.
Documentation requirements as stated in I.R.C. § 41
Accurate and supportable numbers allow you to claim the tax credits you are eligible for confidently.

How complicated is the R&D?

Enacted in December 2017, the Tax Cuts and Jobs Act of 2017 (TCJA) amended Section 174 to require capitalization of all research and experimental (R&E) costs incurred in tax years beginning after Dec. 31, 2021. This rule was a major change in tax policy. Since 1954, taxpayers had been able to elect to deduct R&E costs as incurred. The rule also was a departure from U.S. GAAP, which normally allows immediate expensing of research and development (R&D) expenditures under Accounting Standards Codification 730, “Research and Development.”

Taxpayers were hoping that the provision would be repealed or delayed prior to the due date for filing 2022 tax returns. However, as of the date of publication of this article, the fate of relief remains uncertain. In addition, there are numerous technical and procedural questions about Section 174 amortization that remain unanswered. The IRS has said that it is working on guidance, but nothing has been released yet. Given this background, taxpayers should consider what steps they should take now to manage this uncertainty.

Wow this is way to complicated for me to try on my own

Continued IRS Changes to the Research and Development Credit Program

Section 174 amortization

For tax years beginning on or after Jan. 1, 2022, R&E costs must be amortized over five years if the R&E activities are performed in the U.S., or over 15 years if the activities are performed outside of the U.S., beginning with the midpoint of the tax year in which the costs were paid or incurred. Furthermore, taxpayers may not immediately deduct the unamortized basis attributable to R&E costs for any property disposed of, retired, or abandoned during the amortization period (in other words, the amortization continues for its remaining life).

Because immediate expensing of R&E costs has been permissible for nearly 70 years, it was not necessary to distinguish R&E costs from other immediately deductible expenses. Therefore, for many taxpayers, additional effort will be necessary to comply with Section 174 if it doesn’t get repealed or delayed before their tax returns are due. The extent of that effort will depend on the size of the taxpayer’s business, the industry, the taxpayer’s global footprint, and the taxpayer’s current methods for characterizing these expenses.

In addition, taxpayers will have to consider how capitalizing R&E costs would affect the following:

Cash flow impact. Taxpayers should plan for the impact on the increase in estimated tax payments needed to cover additional federal and state tax liabilities due to the deferral of R&E deductions.
Tax provision impact. The TCJA provision creates a disparity between the timing of deductions for R&E costs for GAAP and the timing of deductions for income tax accounting purposes. Therefore, taxpayers should determine how they will account for deferred tax assets attributable to capitalized R&E costs.
Foreign tax issues/Section 199A deduction. The allocation of R&E costs under Treasury Regulation Section 1.861-17 affects foreign tax credit usage, the foreign-derived intangible income (FDII) deduction, global intangible low-taxed income (GILTI), the base erosion and anti-abuse tax (BEAT), the determination of effectively connected income, and the Section 199A qualified business income deduction. Taxpayers should consider the impact that the deferral of deductions for R&E costs will have on these items.
Tax accounting method changes. Taxpayers historically have been required to file an automatic accounting method change to change from expensing to capitalizing R&E costs. This method change had been on a cutoff basis without requiring an IRC Section 481(a) adjustment, meaning changes were applied on a prospective basis. Currently, the procedures for implementing the TCJA change to IRC Section 174 have not been published. While the IRS could require a method change similar to the current automatic change, this is not the only way that the law could be implemented.
Loss on abandoned projects. Historically, taxpayers choosing to capitalize R&E expenditures for specific projects were permitted to write off the remaining basis if the project was disposed of or abandoned. Under TCJA, taxpayers are required to continue to amortize R&D expenditures over their remaining useful life. This rule seems contrary to other provisions in the IRC relating to abandonment costs, such as IRC Section 165.
R&D credits. Federal and state R&D credits are available to taxpayers that meet the qualification criteria outlined in IRC Section 41. The credit qualification criteria specify that qualified research expenses must meet the definition of R&E expenditures under IRC Section 174. Consequently, taxpayers should consider how capitalizing qualified research expenses will affect the R&D credit. On the bright side, a more thorough analysis of R&E costs might result in opportunities for additional R&D credit benefits. Of note, even if a taxpayer is not claiming an R&D credit, the requirement to capitalize and amortize R&E costs still is applicable.
State and local tax. For states that use federal taxable income, the requirement to capitalize and amortize R&E costs could increase the tax liability at the state and local level.

Research and Development Tax Credit (R&D) Rules and Regulations = 3,922 Pages to Navigate

In 2022, the significant changes to Section 174 went into effect. Enacted in 1954 as part of the Internal Revenue Code (IRC), Section 174 was created to eliminate uncertainty in tax accounting treatment of research and experimental development (R&E, or more popularly, R&D) expenditures and to simply encourage research and developmental experimentation as to way to grow innovation.

Section 174 allows businesses to either deduct or amortize certain R&D costs. Deductions can be made in the year in which they are paid or incurred, or they can be amortized over a period of not less than 60 months, beginning with the month in which the taxpayer first realizes benefits from the expenditures. Below are five things to know now about the updates to Section 174.

1. Which entities are subjected to Section 174 capitalization?

In short, Section 174 applies to any taxpaying entity that incurs qualifying R&D costs independent of specific industry or business size. Specifically, there are several types of businesses that are impacted, including:

Corporations — Regardless of size, once corporations have incurred qualifying research and development costs;
Small businesses including startups — Regardless of current profitability status, small businesses and startups that are heavily invested in R&D may capitalize or amortize their research expenses;
Sole proprietorships, partnerships, and LLCs — Also, these entities can take advantage of Section 174 if they have qualifying R&D expenses; and
Past-through entities including S-corporations — These too can utilize Section 174 for eligible cost associated with R&D, and the R&D credits can be passed through partners, individual shareholders, or members.

2. What qualifies? What are the kinds of costs subject to Section 174 capitalization?

There are several categories of expenses that can be subject to Section 174 capitalization, including:

Salaries and wages — The salaries and wages of employees who conducting or directly supervising or supporting research activities can be capitalized;
Supplies and materials — The cost associated with supplies used in the research process can be capitalized, including anything from lab equipment to the software required for the research;
Patent costs — The cost associated with obtaining patents for a product or process developed through research activities can be capitalized;
Overhead expenses — There are certain indirect expenses that can be allocated to research activities, including utilities for a research lab or depreciation on research equipment; and
Contract research expenses — If a third party is used to conduct the research on a company’s behalf, the cost can be capitalized.

3. What kinds of items are excluded from Section 174 deductions?

Not all R&D expenses can be deducted under Section 174. For example, costs for land or depreciable properties are not deductible. Additionally, costs associated with research conducted after the beginning of commercial production, marketing research, quality control, and funded research (such as research funded by any grant, contract, or otherwise by another person or governmental entity) are generally excluded.

4. What is considered R&D as defined by Section 174?

For tax purposes, the following four-part test from the Internal Revenue Service must be met in order to qualify for R&D credit:

Business purpose — The research must be intended to benefit a business component, which can be any product, process, computer software, technique, formula, or invention that is to be held for sale, lease, license, or use by the company in a trade or business of the company.
Technological in nature — The business component’s development must be based on a hard science, such as engineering, physics, chemistry, the life or biological sciences, engineering, or computer sciences.
Elimination of uncertainty — The activity must be intended to discover information that would eliminate uncertainty about the development or improve of a product or process.
Process of experimentation — The business must evaluate multiple design alternatives or have employed a systematic trial-and-error approach to overcome the technological uncertainty.

5. Which states have conformity to Section 174?

Companies will have to check with the individual state in which they are filling in to determine if that particular state has conformed. States either conform to the IRC Section on a rolling basis or a static basic. A state that conforms on a rolling basis means it will automatically adopt any changes to the federal tax code as those changes occur. Some states that conform on a rolling basis include Illinois, New Jersey, New York, and Pennsylvania.

States that conform on a static basis adopt the federal tax code as of a specific date and do not automatically incorporate subsequent changes. Some static states include Florida, Georgia, Virginia, and North Carolina. There are some states that have selective conformity (this means they adopt selective portions of the IRC), including Arkansas, Colorado, and Oregon.

It is worthwhile to note that levels of conformity can vary by state and may be subject to specific adjustments, additions, or exceptions based on the individual state’s tax laws.

American Innovation and Jobs Act

On March 16, 2023, Sens. Maggie Hassan (NH), Todd Young (IN), and 10 others introduced Senate Bill 866, the “American Innovation and Jobs Act”. The proposal is designed to promote innovation and job growth in the United States by repealing changes to Section 174 capitalization and amortization provisions of the Tax Cuts and Jobs Act (TCJA, also known as the Trump Tax Cuts). The bill also expands the Section 41 Research & Development (R&D) tax credit for qualified small businesses in three ways.

The American Innovation and Jobs Act Explained

The American Innovation and Jobs Act addresses these concerns by repealing the TCJA changes to Section 174. By doing so, the bill will restore the option of immediate expensing of R&E expenditures and return businesses to a more favorable investing and tax environment for research and development.

This repeal is crucial for fostering innovation in the United States, as it reduces the financial burden on all businesses investing in R&D. By allowing companies to immediately expense their R&D costs and claim the deduction against current-year income, the American Innovation and Jobs Act reduces the tax burden of innovation.

Expanding Section 41 R&D Credit for Qualified Small Businesses

In addition to repealing the TCJA changes to Section 174, the American Innovation and Jobs Act also expands the Section 41 R&D credit for qualified small businesses (QSBs) in three key ways:

Extending the duration of the payroll tax offset from five to eight years, providing a longer period of financial support to small businesses investing in R&D.
Increasing the credit percentage for qualified research expenses from 14% to 20%, further incentivizing businesses to invest in R&D activities.
Increasing the cap on the payroll tax offset over the next 10 years from $500,000 to $750,000.

The American Innovation and Jobs Act, through its repeal of the TCJA changes to Section 174 and expansion of the Section 41 R&D credit, recommits to a culture of fostering U.S. technology and growth. By removing unnecessary barriers to R&D investment and further extending financial incentives to small businesses, this legislation is poised to stimulate economic growth and help maintain the United States’ competitive edge in the global market.

We’re urging companies interested in the restoration of Section 174 R&D deduction choices to contact their federal legislators to express their support. For any questions regarding the repeal of Section 174 and expanding R&D Credits please don’t hesitate to contact us.

We’ve Cut Through the R&D Tax Credit Confusion for You

If you tried researching the Research and Development Credit program, or even tried to do this yourself you are fully aware of the confusions and complexities.

Much of the R & D information found on page 1 of Google may already be outdated by the time you read it.

Yeah, This is way too complicated to try on my own!

WOW! Still not convinced you should not try this on your own. Well then, let's try to get you prepared as MUCH AS POSSIBLE!

Quick R&D Checklist

1. Document qualified products and processes

The R&D credit may be claimed for both products and/or services and the respective development processes. This double qualification opportunity puts technology companies in a unique position to maximize the benefits.

EXAMPLE

If a company has designed a new product and must create a new production or software development process to produce the product they bring to market, both workstreams can qualify. Additionally, if you are developing any sort of hardware, the tooling costs incurred for production may qualify as well.

2. Record technical documentation consistently

The best way to ensure you will pass an R&D tax review is to ensure consistent technical documentation. This means you should be actively recording the following throughout your production process:

Specific start and completion dates
Description of the technical challenge
Iterations and versions taken to solve the challenge

The more detail and accuracy you are able to include per your research and development activities, the better.

‍3. Identify all qualified personnel

For most startups, salary is the main component of the R&D credit. The law allows for three different activities to qualify for credit:

The performance of qualified activities

The direct support of qualified activities

The direct supervision of qualified activities

EXAMPLE

If a company is developing a new software as a service (SaaS) offering, the developers, and subject matter experts developing the product’s core value and functionalities are clearly performing qualified R&D activities. From there, an initial product/service must be built with the assistance of the company’s customer success and testing employees. Those individuals and activities may be considered the direct support of R&D. Lastly, assume one of the company’s engineering directors supervises the process from a technical point of view and reports the findings company wide. Those types of activities can also qualify for the credit as the direct supervision of R&D.

4. Identify and maximize appropriate cloud computing expenses

These days, most software companies are using cloud computing as a core part of their business. Only certain uses of cloud computing services count as qualified research expenses (QREs).

A qualified expense must be used in relation to a new or improved product or process, is technological in nature and there is a level of technical uncertainty that can be eliminated through a process of experimentation.

EXAMPLE

Software developers can use a cloud environment to not only perform their development work, but also to design a testing environment to quality control the new code.

Therefore, if there is an experiment you wanted to run, but you were worried about the expected cloud computing cost, you should be relieved that much of that cost is likely qualified to be credited back.

5. Opt for US based contractors and employees

‍While the pandemic has seen an increase in foreign workers and contractors supporting US technology companies, the R&D tax credit incentivizes companies to stay domestic when it comes to employing technical talent.

At most early stage companies the main cost of R&D is salaries. Noting that and the fact that only research activities conducted in the US will count as a qualified research expense, founders should think about using more US based employees or contractors to fuel their product development. There is certainly a tradeoff in labor costs, but the tax code in this case is certainly incentivizing the use of US based technical employees.

This list was created through internal and external research for optimizing R&D credit.

Pointers and Pitfalls

Five R&D mistakes to avoid

Claiming for R&D tax credits is complicated. The legislation is difficult to understand and interpret. You must also know what technical information to include and be aware of potential technological advances. Without all this, you're risking submitting an inaccurate claim.

1. UNDERCLAIMING

It's easy to under-claim by missing out on essential costs you might not know were eligible. While erring on the side of caution can go a long way to avoiding the terrifying pitfalls of putting together an R&D Credit claim, being too cautious can mean losing out on substantial sums of money.

2. UNCLEAR ELIGIBILITY

You risk an inquiry if you are not clear about the eligibility of your projects. You know you are doing R&D; however, the IRS needs it explained in a way that shows the complexity of your project, but in simple terms. They will question your eligibility if they do not understand your supporting report.

3. GRANT IMPLICATIONS

That tiny grant you took can have a significant impact on your claim. If even a penny of state aid touches the costs of an R&D project, the whole project suddenly ends up in the large company scheme. This means that if you have $100,000 of eligible expenditure, that grant you accepted may impact your R & D Credit

4. SUBCONTRACTING COSTS

The IRS might not accept your subcontracting costs if you don't have clear contracts. Consider that company you subcontracted to help with your R&D - do you have a contract that shows they were employed to carry out your R&D? No? Well, you might be in trouble. IRS currently do not ask specifically for contracts, but if an inquiry arises, they'll want to see how every penny was spent on R&D.

5. DON'T RISK IT!

The government wants to ensure that only those entitled to tax benefits gain access to them, and this also applies to R&D tax credits. If you get it wrong, the IRS can open an audit and ask for their money back any time (and we mean years) after you've submitted the claim.

At Legacy, we only see half a dozen out of over 500 claims submitted annually being spot-checked by the IRS. This is entirely due to our well-trained, experienced staff and our PreAudited processes. These guarantee a robust, persuasive narrative and properly documented figures.

We've defended each and every audit claim successfully, achieving a 100% no-change rate for our partners and clients. This means we maintain an excellent reputation with the IRS, which sees us as experienced, knowledgeable, and reliable when writing persuasive narratives for R&D Tax Credit claims.

Make sure you don't miss out on the R&D tax credit opportunity - for a free R&D tax credit consultation and analysis of the potential returns you might expect or to review your existing claim practices, contact us.

You May be Eligible for the R & D credit even for back years! The R & D credit my be utilized three years back and 20 years going forward.

Our Four Step Process

We maximize the value of the credits while reducing the time to obtain them. Our focus is to minimize the time it takes to complete the process ensuring the maximum ROI for your time, which begins with our FREE assessment.

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1) Initial Survey

We request that you complete an initial survey to determine you companies qualifications under the 4-part test

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2) Kick Off Call

Armed with your answers to the 4-part test, we conduct an initial 30 min Kick Off Call with our clients to deep dive into the business and highlight areas where there is significant value. By the end of the call, we will be able to tell you if you qualify for the R&D Credit.

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3) Expense and supporting documentation gathering

In this phase of the process you will be asked to provide the information on the expenses to support your claim. Throughout this phase of the process we will be available to get on a call.

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4 Final Numbers Delivery & Planning

Once we conclude our analysis we will provide the final numbers and an executive summary highlighting our approach. Once the numbers are finalized we will discuss the filing and help you determine the best methods to maximize the value of the credits.

Check out this Sample Plan

Research & Development Credit (R & D) Spotlight:

PreAudited For Your Protection

Our process is why we are different from the other R &D processing services. Every single case that we process is "PreAudited." This means we use the same process that an IRS auditor would use to verify your qualifications for the R & D credit. The IRS R & D Processing Unit only has a limited time to work on each case. They do not have the time for an extensive validation process. While that may be good for your business on the front end, it could be a massive disaster if your business is audited in the future and found not to qualify or qualify for a lesser amount. This could lead to huge penalties and perhaps even a referral to the Criminal Investigation Unit. This is why for every client we process, we PreAudit Every Case. If you are working with a process service that does not have this level of service, We believe you may have a potential huge future liability and not even know it. Processing Services that get paid a commission based on the refund size are incentivized to perhaps overlook things or not verify qualification. And if they are not licensed, wow, you are really taking your chances.

How do you know there are going to be a high number of future R &D Audits?

When firms start advertising R &D Audit Representation Services (ourselves included) the writing is on the wall. Get ahead of this by only working with a firm that PreAudits your R & D Application. If your firm did not conduct a PreAudit as part of the application process, consider having us conduct an R & D Risk Assessment. The best time to start preparing for an R & D audit is before you receive any notiication from the IRS. If you suspect that you may have been misled by a bad actor R & D provider into claiming credits you were not eligible for, the best thing you can do is seek a second opinion from a professional regarding your eligibility and have an R & D risk assessment conducted.

Here's How We Can Work Together

Flexible Options in Working With You or Your Team

There are several flexible options to work with you. The most popular is the Done-For-You (DFY), where we handle everything for you from start to finish.

Done-For-You (DFY)

We handle it all, from start to finish – MOST POPULAR OPTION.

Do-It-Yourself (DIY)

Have us review your work. We will analyze to determine where your package is lacking, needs correction, or lacks support. If you have already submitted your application, we will tell you if you have cause for concern.

Done-With-You (DWY)

Let's collaborate.

Consult-With-You

Customize to your exact needs.

Legacy Tax & Resolution Services DONE FOR YOU (DFY) R&D Service

Legacy Tax & Resolution Services R&D Service can help businesses retroactively claim the Research and Development Tax Credit. Your business will receive the following:

A specially trained R&D expert to review your qualifications
A report providing complete documentation of all calculations
Preparation all required forms

Here's How We Can Work Together. We break our processes down by the number of employees that you have (1-50 employees and 51- 500+ employees)

Do You Have 1 to 50 Employees?

$0 for the Initial Analysis Fee

To dive in and run the numbers

Analysis Fee Upon Engage

We present your refund amount and quote you a Flat-Fee based on the number of qualifying quarters and the number of employees. We charge a refundable fee of $2,500, applied toward the remaining balance upon receiving your refund.

Balance of Fees Upon Refund

The balance of the fees is due within 7 days of receiving your R&D refund check.

In this case, there is no initial fee or risk to you for us to get started and dive in and run the numbers, even though there is still a lot of work on our end.

We'll have an initial conversation with you and ask specific questions to ensure your business qualifies under the revenue test. Before this initial conversation, you will have been sent an initial survey to assist with your initial qualification conversation.

We'll send you client requests for documents needed to support your application thoroughly. We will also ask that you complete and sign an IRS Form 8821- Tax Information Authorization that will be used to track your case with the IRS.

It should take you about 10 minutes to gather and upload the required documents via our secure portal,

Our Tax Advisors will methodically determine your eligibility quarter-by-quarter for 2020 and 2021,

Then run the payroll calculations employee-by-employee for eligible Qualified Wages.

We will subtract out any PPP loans, R &D Credits, Work Opportunity Tax Credits (WOTC), Families First CoronaVirus Response Act (FFCRA) Credits, Shutter Venue Operators Grant (SVOG), Restaurant Revitalization Fund (RRF), and other tax benefit programs you may have received from your qualifying wages. Next, we will remove any disqualifying owners and family members from employee-qualified wages, and the final maximum ERC Refund will be determined.

These numbers are checked 3x's by 3 separate Tax Advisors to ensure we have the correct and maximum R & D Refund you qualify for.

Our application packages are by-the-book and per current IRS rules and guidelines. We literally PreAudit every case and provide well-documented support for every application.

At this stage, we review your R & D Refund amount with you; that is where you can decide if you want us to proceed.

We'll quote you a reasonable flat fee amount to finalize everything.

Most clients say YES at this point because we have already put in a lot of work, and our flat fee to proceed ahead to finalize your R & D Claim is less than what most professional R & D processing firms charge.

Then, we take all the work done up to that point and prepare and fill out the correct tax return forms to claim the R & D credit and provide the proper support documentation to support your claim.

We will send the final Form for your signature and submission to your tax professional or return to our office for processing.

We will use Form 8821- Tax Information Authorization obtained from you as part of our information gathering to track your case with the IRS.

Upon the IRS' completion of the review of your case, your business will receive a check directly from the IRS for your R & D Refund.

The balance of the fees will be due within 7 days of receiving your R & D refund check.

Do You Have 50 to 500+ Employees?

$2,500 fee for the analysis

We charge a refundable fee of $2,500, applied toward the remaining balance upon receiving your refund, to dive in and run the numbers.

Balance of Fees Upon Refund

The balance of the fees is due within 7 days of receiving your refund check.

This is how we engage because there's much more upfront work for companies with more than 50 employees.

The process is the same as listed above, with the only difference being to charge $2,500 to perform the analysis.

We run through the same systematic in-depth process.

To start the analysis, you would be charged an upfront fee of $2,500.

Our Three Step- Your 6 Hours Away From A Lot of MONEY

Kick-Off Call- 30 minutes

We conduct an initial 30 min Kick Off Call with our clients to deep dive into the business and highlight areas where there is a significant value.

Upload Documents- 1.5 hours

It will take you about 10 minutes to gather these documents and upload them to your secure portal. We take security very seriously. The details and the bulk of the time will be spent completing the narrative for the 4-part qualification test. This is where the majority of the time will be spent in creating the supporting documentation. We will provide very detailed and instructive questions and examples as part of our survey to full support the 4-parts test as part of supporting document for your application. Once the package is complete, if your are audited, your can feel comfortable knowing your are ready!

Deep-Dive Analysis to Verify Eligibility, Run Calculation and Determine Maximum R & D Refund

Once we get all of the documents, our Tax Advisory Team will analyze your expenses.

We will then analysis your responses to our extensive surveys to support the 4-part test.

Everything we do is thorough and accurate to help you maximize the total R & D Refund you’re legally allowed by the IRS based on your documentation.

Please Note: This is a very simplified description of the process and workflow. However, there are many complex details, IRS rules and regulations, and unique circumstances that determine your company eligibility and total R & D Refund amount. There are some businesses that may not qualify for the Research and Development Tax Credit program after going through this deep-dive process.

Quickly Provide a Preliminary Report- 3 Hours

We provide you with a quick preliminary report of the opportunities and then dive in to the details

Analyze The Data

Our experts review your business activities ensuring that all credits and incentive requirements are satisfied, and the appropriate opportunities are identified

Final Numbers & Delivery Planning- 2 hours

We will provide the final numbers and an Executive Summary highlighting our approach. Then we will determine the best methods to maximize the value of the credits.

Document Credits

Our audit ready final report includes the supporting documents necessary to claim and support each credit or incentive requested

Secure the benefits

We provide your company all the necessary forms and instructions necessary to claim the credits and incentive due to your company.

FAQS

See how do Businesses received the credit

Our Research & Development Tax Credit FAQs

IRS' Employee Retention Tax Credit FAQs

Myths About ERC

Do the Owner's Wages and Those Related to the Owner Qualify For The Employee Retention Credit?

Determining Eligibility for the Employee Retention Credit

What is the definition of Qualifying Wages for the Employee Retention Credit?