Why You Should Invest in R&D Tax CreditsAugust 31, 2021
Has your business taken advantage of research and development tax credits? R&D tax credits have long been a way to reduce tax liabilities and free up cash for growth and expansion.
Given the increasing responsibilities, challenges and economic uncertainty brought on by the COVID-19 pandemic, all businesses are looking for ways to better manage their cash flow. Research and Development (R&D) tax credits can help. According to the Joint Committee on Taxation, the R&D tax credit will reduce tax revenue by about $11.8 billion in 2020—savings of $10.6 billion for corporations and $1.2 billion for individuals. Here’s how you can benefit.
What is the R&D Tax Credit?
The Research & Development (R&D) tax credit is for businesses of any size that design, develop or improve products, processes, techniques, formulas, or software.
What does the credit apply to?
Qualified research must meet the following four criteria:
- New or improved products, processes, or software
- Technological in nature
- Elimination of uncertainty
- Process of experimentation
Eligible costs include employee wages, cost of supplies, and contract research expenses.
How much is the credit?
The R&D Tax Credit allows a federal dollar-for-dollar credit of roughly 10-16% of eligible spending for new and improved products and processes. Many states also allow credits for eligible in state spending.
How do you calculate the credit?
There are two standard methods of calculating the R&D tax credit -- the regular research credit (RRC) method and the less complicated alternative simplified credit (ASC) method.
The ASC equals 14% of the QREs for the taxable year that exceed 50% of the average QREs for the three taxable years preceding the credit determination year. (If the taxpayer has no QREs in any one of the three preceding tax years, the ASC rate equals 6% of the QREs for the credit determination year.)
Make sure you are using the method most advantageous to your company as discussed in our blog here https://kahnlitwin.com/blogs/tax-blog/calculating-the-r-d-tax-credit-rrc-vs-asc-method
R&D Payroll Credit
Low revenue startup companies that are eligible to claim the R&D payroll credit can realize immediate cash savings with the R&D payroll credit.
To be eligible for the credit, an entity must have:
- Less than $5 million in gross receipts over a five-year period and
- No gross receipts before the five-year period ending with the tax year.
As a qualified small business with QREs, companies can apply up to $250,000 of the credit against their payroll tax liability. Calendar-year taxpayers can apply the credit against payroll taxes as early as April of the following year.
New Products, New Wages
Many companies are finding new ways to do business in light of the ongoing COVID-19 pandemic. Earlier in 2020, some businesses shifted production to fill a gap in the need for medical protective equipment or other virus-related supplies—check out our blog https://kahnlitwin.com/blogs/tax-blog/adapting-for-covid-19-and-the-r-d-tax-credit.
Despite this, most organizations still rely on old research tax credit studies or outdated standard time allocations, possibly understating QREs. Make sure your company evaluates the associated qualified research expense for these new research projects to maximize R&D credits.
Current federal legislation proposals hint at some of the changes being considered including:
- Eliminating the regular credit and replacing it with a modified alternative simplified credit,
- Expanding the credit’s benefits for startups by raising the maximum amount of payroll tax liability that can be offset by the R&D credit from $250,000 to $750,000.
- Expanding eligibility for the startups by raising the gross receipts threshold to $15 million and allowing a claim for eight years,
- Repealing the TCJA tax law changes that will require mandatory amortizing of research and development costs starting in 2022. The change would spread out the deduction over five years for activities in the U.S., and 15 years for non-U.S. activities.
R&D tax credits can be a vital part of an overall plan to reduce your liabilities and increase your cash flow for companies who are improving or creating new products, processes, or technologies.
We are here to help you navigate through the existing requirements, as well as comply with and take advantage of any new legislation. Do not hesitate to contact any member of our KLR service team for assistance.