Tax-paying organizations are allowed to claim the R&D tax credits for qualified research expenditures, which cover more than you might think.

Taxpaying organizations are allowed to claim the R&D tax credits for qualified research expenditures, which cover more than you might think.

Taxpaying organizations are allowed to claim federal tax credits for qualified research and development (R&D) expenditures, according to the IRS. These tax credits can help businesses stay competitive in changing markets. After all, businesses need to invest in order to grow. The R&D tax credit can help many organizations make money in the future with less money spent today.

The Benefits of Tax Credits

Generally speaking, in tax terms an expense or tax deduction reduces taxable income, which in turn reduces the amount of tax owed. With capitalization, the costs of an expenditure are spread out over the useful life of the investment, turning a one-time cash outlay into a series of smaller expenses over several years (depreciation and amortization). This allows organizations to realize the tax savings right away, making it valuable. A tax credit can be even more valuable than an expense or deduction. A tax credit, like the R&D tax credit, reduces the amount of taxes already owed, leading to bigger tax savings.

According to the IRS, the range of costs allowed for the federal R&D tax credit is broad. They do not have to relate to the nature of the product or improvement being developed, nor to the amount of technological advancement. Instead, they can include costs for work on formulas, inventions, patents, pilot models, processes and techniques. Often, finance leaders and their tax advisers find that some business expenses actually qualify for the R&D tax credit, helping their organization save money for future investments.

How to Use the Tax Credit

According to IPC, there are operational costs that may qualify as eligible R&D expenses under the Internal Revenue Code (IRC). For example, investments in process improvements — including wages paid to employees working on qualified R&D activities — could be included as a Qualified Research Expenditure (QRE) under applicable laws and regulations.

Qualified Research Expenditures

The IRS does audit to make sure that organizations taking R&D credits actually qualify for them. According to IPC, finance leaders should be sure that documentation exists to show the goal is to discover technological information that their organization doesn't already have (or improve something they already have), that there's a level of uncertainty related to the work, that costs are directly attributable to this process of experimentation and that the research is carried out as part of an effort which is performed as a permitted purpose under R&D tax credit regulations.

In other words, you probably can't use the tax credit for an off-the-shelf solution, but you probably could use it if you had to try a few things before finding something that worked for your business. The R&D tax credit is designed to help organizations stay on top of their markets. If it saves you money, so much the better.

UPDATE: Bill Expanding Federal R&D Tax Credit Introduced in Congress

Senator Margaret Wood Hassan (D-NH) recently introduced the "Research and Development Tax Credit Expansion Act of 2019" (S. 2207), a bill which would expand the refundability portions of the existing credit for increasing research activities for qualified small businesses. The bill is co-sponsored by Senator Thom Tillis (R-NC).

Features of the bill include the following:

  • Doubling the Cap on the Refundable Credit – The bill would increase the current $250,000 maximum amount of credit that a taxpayer can elect to apply against payroll taxes per year to $500,000. The increased maximum would allow qualifying taxpayers to apply more credit against payroll taxes, which could result in a quicker realization of the incentive.
  • Indexing for Inflation – For tax years beginning after 2020, the bill would index the new $500,000 annual maximum payroll tax election amount so that the cap is adjusted annually to reflect increases in the Consumer Price Index.
  • Expansion of Eligibility Threshold – The bill would increase the current gross receipts threshold for a "qualified small business" from $5 million in gross receipts to $10 million. The increased threshold would allow more taxpayers to take advantage of the election to apply the R&D credit against payroll taxes.
  • Increased Alternative Simplified Credit – The bill would modify rules regarding the calculation of the Alternative Simplified Credit. For a qualified small business, the credit percentage for the Alternative Simplified Credit would increase from 14 percent to 20 percent of the amount by which qualified research expenses exceeds 50 percent of the average qualified research expenses for the previous three tax years. For a qualified small business with no qualified research expenses in the previous three tax years, the credit percentage would increase from 6 percent to 10 percent.

Enactment of the legislation should result in an expanded credit for qualified small businesses, as well as an expanded base of taxpayers eligible for qualified small business treatment, thus opening the door for more companies to avail themselves of the credit opportunity. "The difficulties in securing these R&D tax credits are associated with understanding the eligibility requirements, IRS guidelines and legislation, as well as the significant time investment in gathering the mandatory documentation needed," said Tony Miskowiec, senior vice president, general manager of ADP Tax Credits. "At ADP, we see R&D tax credits as a rewarding, yet untapped opportunity for many companies to improve their cash flow and positively impact their financial statements. We also realize the process is a significant undertaking, which is where our expertise can address the complexities of claiming R&D tax credits and documenting qualified research expenditures."

To learn more about the federal R&D tax credit, including provisions which specifically benefit qualified small businesses, join us for our webcast, by visiting this link.

This article was updated on September 20, 2019.

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