R&D Tax Credit FAQ (Frequently Asked Questions)
What qualifies as research and development?
The 4-part test defining R&D activity defines qualifying activity as: 1) Activity undertaken to develop a new, OR improve existing: products, processes, formulas, inventions, software, or techniques, 2) which seeks to overcome some form of uncertainty relating to: the ultimate design of a product, methodology to achieve the end result, or capability to achieve the desired result of the project, 3) Which involves an iterative process of experimentation, or trial & error, to achieve a desired result, 4) And is technological in nature, or based in hard sciences (mathematics, computer science, chemistry, biology, physics, etc.)
What qualifies for the R&D tax credit?
Companies in manufacturing, technology, architecture & engineering, government contracting, systems integration, agriculture, winemaking/brewing/distilling, and software development frequently qualify for research and development tax credits.
What expenses qualify for research and development tax credit?
The tax code allows for three categories of R&D tax credit costs to be captured for research and development credit purposes: qualifying wages, supplies, and contractor expenses. Travel expenses related to R&D and capital equipment costs do not qualify as R&D expenses. Some server expenses for computer based activity can qualify, as well as expenses associated with developing software that is used internally within a company.
When can you claim R&D tax credit?
You can claim the IRS R&D tax credit each year to offset tax liability on your federal tax filings, and state filings depending on which state your business operates in. IRS Form 6765 is filed withing your federal tax filing (Form 1120, 1120S, 1065, etc.) Therefore R&D tax studies must be conducted prior to filing deadlines. Additionally, you can go back and amend the last three years of tax returns if you failed to file for R&D credits in those years, in which case you will receive refund checks from the government in the amount of credit claimed for those returns.
How much R&D can you claim?
The amount of R&D credit claims depends upon your annual R&D spend. Generally, a taxpayer can recoup 7-10% of their annual R&D spend in the form of an R&D credit. Therefore, the limiting factor in most cases is the amount of qualifying R&D spend. However, if you are a start-up company (in your first five years of revenue generation, and under $50mm in gross sales) seeking to offset your payroll tax with R&D credits, the tax code limits the amount of claim to $250,000 annually.
How do you calculate the R&D tax credit?
The IRS allows for three calculation methods. Each of the methods take into account a different “base period” and then compares the current tax year to that base period to measure the requisite “increase” in R&D activity. The amount of the R&D credit hinges on this “increase,” although a credit can be generated even when R&D spend remains flat year over year. The methodology appropriate for each taxpayer depends on the taxpayer’s financial records, year of founding, and relative R&D spend in the current year versus previous years.
How does the R and D tax credit work?
The R&D credit allows U.S. taxpayers to re-capture roughly 10% of their qualified annual R&D spend (wages, supplies, and contractor costs) as a tax credit. The qualification and calculation methodologies are laid out in Section 41 of the Internal Revenue Code. The legislation around the credit is constantly evolving. As recently as 2022 significant changes have come into play. The R&D credit is the most lucrative tax credit offered by the tax code, but requires a breadth and depth of expertise to calculate and capture properly.
How much R&D can you claim?
This is a multi faceted question, and therefore has a multi part answer. The regular federal R&D credit calculation is not limited in its amount. However, Section 41(g) places limitations on the type of income sources that the credit can be used against, in certain entity types. In addition, the start up credit that was created in 2015 limits the R&D credit to $250,000 per year for use against payroll taxes.
Is there a limit on R&D tax credit?
The federal government does not limit the amount of a regular R&D credit a taxpayer can claim. However, some states limit the amount of funding available to taxpayers. Start up companies in their first five years of revenue are limited to $250,000 of R&D credits annually to offset payroll tax liability.
How much is the research and development tax credit?
The amount of credit depends on the taxpayer’s annual qualifying R&D spend. Generally speaking, the credit will equate to roughly 10% of a company’s qualified R&D spend each year.
Who qualifies for the R&D credit?
U.S. companies that conduct everyday activities within the U.S. in the following industries can qualify for R&D credits: Aerospace & defense, architecture & engineering, technology & software, government contracting, manufacturing, winemaking, brewing, distilling, agriculture, cannabis & industrial hemp, biomedical & pharmaceutical, and food & beverage. This list is not exhaustive, but represents the majority of qualifying industries. If you have questions about qualifying industries and activities, contact an expert today for a free assessment.
How do you claim credit for increasing research activities?
Section 41 of the Internal Revenue Code, as well as a multitude of other IRS guidance, dictate how a R&D credit must be calculated and documented. Some CPAs calculate R&D credits, but most tax practitioners and taxpayers are better served by an outside specialty firm. Nine times out of ten we are able to find additional credits that were overlooked, and we provide all of the necessary documentation to prove up the claims.
Is an R&D tax credit taxable income?
No, the research and development tax credit is not taxable income.
Is the R&D credit refundable?
Some states offer refundable credits. The federal credit is not refundable.
Does the R&D credit reduce expenses?
No, the research and development tax credit does not reduce expenses.
How many years can you claim R&D credit?
A taxpayer can claim credits in every year they conduct qualifying activities and incur R&D expenses in the form of qualifying wages, supplies, and contractors costs.
How far back can you claim R&D tax credits?
In most cases, we can capture credits for the 3 past years of tax returns to file for refunds. Some states have four year statutes, which allow us to look back 4 years for refunds.
Does the R&D Credit Bring Increased IRS Scrutiny?
No. IRS reviews for taxpayers claiming R&D credits are on par with national averages across all taxpayers. However, the IRS does require evidence of R&D claims, so it is important to conduct R&D studies properly, and in line with IRS guidance that is evolving almost every year.
This page was last updated by Steven Jefferies.
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