Who Qualifies for R&D Tax Credits?
The R&D tax credit is available to companies developing new or improved business components, including products, processes, computer software, techniques, formulas or inventions, that result in new or improved functionality, performance, reliability, or quality. It’s available at the federal and state level, with over 30 states offering a credit to offset state tax liability.
R&D tax credits can also be retroactive. Depending on when your tax return was filed, you may be able to claim R&D credits for three prior open tax years. Loss companies may be able to go back even further; some states also allow more than three years for retrospective claims.
What is the R&D Tax Credit?
It’s a dollar-for-dollar tax savings that directly reduces a company’s tax liability. There’s no limitation on the amount of expenses and credit that can be claimed each year. If the federal R&D credit can’t be used immediately or completely, then any unused credit can be carried back one year or carried forward for up to 20 years. Each state has its own carryover rules.
The R&D tax credit regularly provides a wide range of businesses with a source of extra cash—up to 10% of annual R&D costs for federal purposes and much more when state credits are factored in.
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Common R&D Misconceptions
No Income Tax
Start-up companies and small businesses may be eligible to apply up to $1.25 million—or $250,000 each year for up to five years.
No R&D Focus
Most companies don’t have R&D laboratories and instead perform R&D in their test kitchens or fields, wineries or distilleries, or on production floors.
No Scientists
Experimentation performed by both employees and third-party contractors who engage in the improvement of projects and processes may be included.
No-Innovation
R&D simply needs to be new to the company, which must have activities that meet the four-part test below.
R&D Credit Eligibility Criteria
Qualified Purpose
The purpose of the research must be to create a new or improved business component, resulting in a new or improved function, performance, reliability, or quality. A business component can be a product, process, computer software, technique, formula, or invention—a broad definition that applies to many different industries.
Technological In Nature
The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology, or computer science. It’s important to note companies aren’t required to exceed, expand or refine existing scientific principles.
Litmus Test
As a first step, a company should review its operations for eligible activities. Companies that go on to claim the credit must also be prepared to identify, document, and support their qualifying R&D activities.
Elimination of Uncertainty
A company must demonstrate it has attempted to eliminate uncertainty about the development or improvement of a business component. Uncertainty exists if the information available to the company doesn’t establish the capability or method for developing or improving the business component, or the appropriate design of the business component. Many companies are confident in their ability to achieve technical objectives or have an established method for finding solutions, but the design is seldom established at the project’s onset.
Experimentation
A company must demonstrate—through modeling, simulation, systematic trial and error, or other methods—that it has evaluated one or more alternatives for achieving the desired result. Some activities naturally follow an iterative trial and error process. For example, engineering, software development, or clinical research activities all rely on a process that can evaluate one or more alternatives. The definition is also broad enough to apply to many other types of activities.
Can You Claim R&D Credits?
The amount of R&D tax credit a company can claim will depend on many factors, but the potential tax savings make it worth the time to investigate. For example, R&D tax credits have the potential to offset income tax, which can reduce a company’s tax burden in the years qualified activities occur.
Companies that haven’t previously taken advantage of the credit also have the option to look back at all open tax years—typically three to four years, depending on when tax returns were filed—to claim the missed opportunity.
If a company doesn’t currently have taxable income or is otherwise limited in how much tax credit it can use, the federal tax credit can be carried forward for 20 years or potentially applied to offset the company’s federal payroll tax under the newly expanded rules. State credits may also be carried forward for a length of time determined by the state.
FAQs
Who qualifies for the R&D tax credit?
The R&D tax credit is open to companies from any industry in the U.S. that are working to improve or develop a process or product.
What are the limitations of the R&D tax credit?
For the 2016-2022 tax years, the maximum R&D tax credit for payroll tax is $250,000 for companies meeting the criteria of a Qualified Small Business. Starting January 1, 2023, the maximum credit amount is $500,000.
How far back can you claim R&D tax credits?
R&D tax credits can generally be claimed as long as the statute of limitations is open, which is usually the previous three years.