Maximize Your R&D Tax Credit Benefits
According to the Internal Revenue Service (IRS) of the United States, a tax credit “is a dollar-for-dollar amount taxpayers claim on their tax return to reduce the income tax they owe. Eligible taxpayers can use them to reduce their tax bill and potentially increase their refund.”
Credits are generally created to encourage, incentivize, or reward some kinds of behavior determined to be beneficial to the economy and the environment, or to advance any other purpose governments consider important. Research and development are obviously beneficial to the economy and the environment, which is why they are deemed important by governments. This led to the creation of the IRS research and development tax credit, or increasing research activities credit, as one of the various kinds of tax credits in the US.
So what is the R&D Tax Credit? The answer is not far away. If you’ve also been wondering about how to claim R&D tax credit, then this post is for you.
A few minutes of your reading time will furnish you with what you need to know about how to claim R&D tax credit as well as provide insight into the question: What is the R&D tax credit? There are also details on other areas surrounding the topic.
What is the R&D Tax Credit?
The IRS research and development tax credit (also known as the increasing research activities credit) is an IRS tax incentive that rewards companies engaging in research and development activities such as developing new products, processes, or inventions. It offers a significant percentage in tax savings to such companies for qualified research activities and qualified research expenses.
R&D Tax Credit and Deductions Explained
Over the years, the US Congress has enacted a couple of important incentives aimed at encouraging businesses to invest in research activities in the country. The two laws provided businesses with the ability to elect to deduct research expenditures currently and the permanent ability to claim credit for increasing research expenditures.
The first enactment (deductions) occurred in 1954, when Congress enacted I.R.C. §174. The law empowered taxpayers to either currently deduct research or experimental expenditures paid or incurred “in connection with” a present or future trade or business or elect to amortize these costs over a duration of not less than five years. It was meant for expenditures incurred after December 31, 1953. Among the eligible research costs are those paid for or incurred for research done by the taxpayer and research conducted on behalf of the taxpayer.
I.R.C. §174 was enacted for the purpose of encouraging taxpayers to incur research and experimental expenditures by removing the uncertainty surrounding the tax treatment of these expenditures.
The second enactment, which took place in 1981, was born out of concern that spending for research and experimental activities was not only insufficient but was actually on the decline. Therefore, Congress enacted I.R.C. §41 (The Research and Experimentation Tax Credit—part of the Economic Recovery Tax Act [ERTA] of 1981) on a non-refundable income tax credit for incremental research and experimental expenditures to address the reluctance of companies to bear the substantial costs of staffing and supplies necessary to conduct research in a trade or business. I.R.C. §41 was originally introduced as a temporary measure in the ERTA.
The incremental nature of the increasing research activities credit is meant to encourage companies already engaged in some research activities to further widen the scope of their research efforts. I.R.C. §41 subsequently became a permanent provision of the Internal Revenue Code as part of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). The PATH Act also modified the benefit of the research and development tax credit for small businesses and made it available to startups. Further legislative changes have since made the research and development credit more lucrative and available to nearly every industry.
Understanding the Importance of the Research and Development Tax Credit
Today, the IRS research and development tax credit helps position the U.S. at the forefront of innovation. There is significant evidence that R and D tax credits stimulate additional research spending. Previously, there was a belief that credit had a relatively small effect on new investment. A report by the Government Accountability Office (GAO) examined the initial impact of the research & development tax credit on R&D in 1989 and found that its impact was modest. The report estimated that the cost of the research and development credit in terms of forgone tax revenue was $7 billion and that it stimulated between $1 billion and $2.5 billion in new research spending (or that $1 in tax subsidy created between 15 and 36 cents of R&D spending).
Another 1989 paper - this time a literature review - found a slightly stronger tax credit effect on research spending. The review estimated that $1 of forgone tax revenue generated between 35 and 93 cents of new research spending. Some researchers have compared R&D spending before and after the Omnibus Budget Reconciliation Act of 1989, which modified several rules associated with the R&D tax credit. They concluded that $1 of research and development credit stimulated $2.08 in new R&D spending. In 2000, a study found that $1 of R&D tax credit generates about $1 of new investment in R&D.
Larger effects have been reported in more recent research. For instance, a paper published in 2016 investigated the R&D tax credit’s first 10 years of existence in the US and found a 10% decline in the user cost of R&D spending. Also, the ratio between the research and sales or revenue of a firm (known as the R&D intensity) increased by 11%. Another recent study in 2017 found that in the long run, $1 of R&D tax credit will generate about $4 of R&D spending.
One reason adduced for the greater responsiveness of firms to the R and D tax credit of recent years is that policy changes over time have made the credit more effective. There’s also a possibility that the better outcomes are because firms have now developed a better understanding of the credit’s structure than when it was first introduced.
Claiming the R&D Tax Credit with Wilkins and Co.
Companies in the United States enjoy some of the richest R&D tax incentives in the world. But there are businesses that have been eligible for R&D for many years without realizing it. If you are a newbie in tax matters, you may be in the dark about how to claim the R&D tax credit. Business organizations can claim their R and D tax credits by filing IRS Form 6765.
Part of the process requires that eligible businesses determine which of their expenses qualify and also ensure adequate documentation to substantiate their R&D expenses. Documentation should include financial records showing expenses, business records, or oral testimonies that specify which expenses were related to qualified activities, as well as technical documents that provide details about how the qualified activities satisfy the requirements of Section 41.
Form 6765 is a vital document for businesses involved in qualifying research activities and intending to claim the IRS research and development tax credit. There are a couple of different ways to file the form. You can complete the form via a DIY approach, albeit at an increased risk of making serious mistakes that can undermine your quest for research tax credit. Another option is tax software. This can also be overwhelming, especially if you are not very tech-savvy or knowledgeable in the field of research tax credits.
Your best option to maximize your R&D tax credit benefits? Contact a tax professional at Wilkins and Co. Business Consulting to file on your behalf. Wilkins and Co. boasts research & development tax credit professionals with several years of experience in completing Form 6765, meaning that they will ensure you avoid common filing errors while helping speed up the entire process. Headquartered in Fairfield, Iowa, Wilkins and Co. provides financial advisory and operational accounting services to founder-led businesses and startups.
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What Exactly is the Research and Development Tax Credit?
The IRS research and development tax credit is an IRS tax incentive that rewards companies undertaking research and development activities, which may include (but are not limited to) developing new products, processes, or inventions. It offers a significant percentage in tax savings to such organizations for qualified research activities and qualified research expenses.
How Does Form 6765 Relate to the R and D Tax Credit?
Form 6765 is essential for those wishing to claim the research and development credit. The form requires detailed information about a company’s eligible research activities and expenses, as well as the methodology used to calculate the credit. Generally, 6-8% of a business’s qualifying expenses can be applied against its federal income tax liability (dollar for dollar). Form 6765 must be attached to the business's tax return to claim the research credit.
What Advantages Can Businesses Gain From R&D Tax Credit?
● Ensures dollar-for-dollar reduction in federal and state income tax liability
● Can help achieve higher earnings-per-share
● Provides over $7.5 billion in federal R&D tax credits annually
● Lowers your effective tax rate
● Tax credits can be carried forward up to 20 years
● In addition to the federal R and D tax credit, several state R&D tax credits are also available
● Ability to perform look-back studies to recognize unclaimed credits for open tax years (usually 3 or 4 years)
● Companies can leverage the federal research & development tax credit against payroll tax (applicable to some startups)
● Reduces the cost of innovation and improves cash flow for many small and mid-size companies
● Helps position businesses to transform their industries
● Enables businesses to reinvest for even more development