The federal R&D tax credit carryforward is a provision within The Research and Experimentation Tax Credit enacted under the Protecting Americans from Tax Hikes (PATH) Act of 2015. Since the R&D tax credit was introduced, large and small enterprises have benefited. SMEs account for the majority of R&D tax relief because of the generous carryforward provision.
If your business has R&D expenses, then you’ll want to claim this tax credit even if you’re operating at a loss. We’ll explain why companies should leverage the R&D tax credit carryforward, the rules associated with the carryforward, and answer some common questions related to the carryforward.
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What is the R&D Tax Credit Carryforward?
The carryforward provision enables businesses to apply any unused credit from the current tax year’s qualified research expenses (QREs) to future tax liabilities. This is especially helpful to start-ups and small businesses that have investments in research and development and were eligible for a more considerable tax credit than they needed because the company didn’t have a significant taxable income within the current tax year.
Businesses can claim the R&D Tax Credit and apply unused credit back one tax year and forward for twenty years to offset future tax liabilities as the business grows in profitability. If your business innovates in any capacity, you’ll want to examine closely to see if your activities and expenses can qualify for the credit.
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How Does the Carryforward Work?
To claim the carryforward credits, a company must apply them to an open, amendable tax return or use them on a future tax return to offset future income tax.To apply for the R&D tax credit, a company needs to:
- Perform a R&D tax credit study to assess qualifying activities and expenses.
- Gather all necessary documentation to substantiate the claim.
- File an IRS Form 6765, Credit for Increasing Research Activities, with your tax return.
Essential Details About Validating Your Claim
When gathering documentation to claim the R&D credit for this year or for amending a previous year(s), you’ll need to provide specific documentation outlined by the IRS that:
- Identifies all components that relate to the research activities for that year.
- Specifies for each component all research activities performed, all individuals who performed each activity, and all information each individual sought to discover. (amended years only)
- Provides the total qualified employee wage expenses, supply expenses, and contract research expenses for the claim.
- Signs and states the form is accurate under penalty of perjury.
The IRS has recently issued this guidance to manage and validate QREs more efficiently. This also reduces the number of businesses that make claims without factual support.
Do the Carryforward Rules Change Depending on Your State?
Yes. Some states, like California, do not place a twenty-year expiration date on unused R&D tax credits. So while you won’t be able to use the unused credit at the federal level, you may still apply the credits at your state level. Each state varies and some states don’t allow carryover at all.
Depending on where you do business, you’ll want to consult with an accounting expert who specializes in R&D tax credits to learn how you can best leverage the tax credit and reduce your tax liabilities in the future.
Need help creating the best strategy for your R&E Tax Credit carryover? Learn more about our proven R&E Tax Credit services.
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Can You Still Claim the R&D Credits for Previous Years?
Yes. If you haven’t been taking advantage of this tax credit and have QREs that you can document from the past three years, you can file an amended tax return to take advantage of the carryforward provision.
If your business suffered losses for longer than the previous three years, you might be able to claim retroactive R&D tax credits further back. You’ll want to talk to an accounting specialist in R&D tax credits to see if your business may qualify.
Does the Carryforward Expire?
Yes. If a business does not use the credit within the twenty-year carryforward period, the business will no longer be able to use the credit to offset tax liability. The carryforward will work as a deduction after the twenty-year period. So it is very important to consult with accounting experts that can help strategize the best way to apply the carryforward to take full advantage of the unused credit.
How Did the Tax Cuts and Jobs Act Affect the R&D Tax Credit Carryforward?
The Tax Cuts and Jobs Act (TCJA) enacted several benefits for C-corporations. Some of these benefits affect the R&D tax credit carryforward by:
- Eliminating the alternative minimum tax (AMT)
- Amending Internal Revenue Code Sec 172(a) to limit the net operating losses (NOLs) deduction to 80% taxable income
- Restricting businesses with more than $25,000 in regular tax liability to offset more than 75% of the tax liability by utilizing the R&D tax credit.
Final Thoughts
The R&D tax credit carryforward is essential for any business that has research activities and expenses regardless of industry. The carryforward was designed to dramatically help SMEs and start-ups leverage their initial R&D expenses to help their business gain footing in the future by reducing their future tax liability. It is critical for businesses to document, track, and record all activities and expenses that could qualify for the tax credit, even when you are operating at a loss.
Parachor Consulting has experienced tax professionals that can help you identify, evaluate, and document QREs to claim an R&D tax credit. We specialize in helping small to medium-size enterprises qualify for tax credits like R&E.
Want to know the R&E tax credits for your state? Contact Parachor Consulting, who can help you maximize your tax credit eligibility.
Related Link: How to Offset AMT with R&D Credits in 2022
