How can your business benefit from the R&D tax credit?

Qualifying businesses can significantly reduce their annual tax liability by applying R&D tax credits. Most entity types can qualify for R and D tax credits, including LLCs, Partnerships, S-Corps, and C-Corps. Although all these business structures can claim credits, the treatment and flow of credits is different for each type of entity. For example, credits filed on a Form 1120 serve to reduce a C-Corp’s tax liability at the entity level, whereas credits filed on a Form 1120-S flow through to each of the shareholders’ personal tax returns (1040s) to reduce tax liability at the shareholder level.

The first step to capturing R&D credits is to identify and qualify certain personnel and activities within your business. This process requires knowledge in both industry-specific activity, as well as detailed expertise into the nuances of IRC Sections 41, 174, and published IRS guidance. Once the qualifying personnel and activity are identified, it is necessary to extrapolate the associated wages, supplies, and contractor expenses that will contribute to the R&D credit calculation.

There are a few calculation methodologies available. Each differs in terms of the inputs it requires. One method looks back to a historical base period, while another requires only information from the past 3 years of activity. The ideal methodology depends on several variables. Once the credit is calculated, IRS Form 6765 is completed with all the necessary elections made.

After the credit is calculated, it is necessary to commemorate the appropriate documentation to substantiate the taxpayer’s credit claims. This includes producing a report to detail the methodology used to claim credits in all given tax years. The crux of this report is to show a nexus between the personnel conducting qualifying R&D activity with the qualified projects they were involved in, and the expenses associated with those projects (wages, supplies, contractors). This report completes the process of substantiating the taxpayer’s research and development claim in each tax year they benefit from the credit.

This page was last updated by Steven Jefferies