Made a permanent tax credit in the Protecting Americans from Tax Hikes (PATH) Act of 2015, The Research and Experimentation Tax Credit allows businesses and individuals that are innovating, researching, and experimenting in some capacity to incorporate the credit into the tax-planning strategy. This especially benefits start-ups and small businesses.
Unfortunately, many businesses overlook this valuable tax credit because they don’t think they have expenses that will qualify. We’ll explain why you’ll want to claim the R&E Tax Credit, what qualifies as an expense, and how to protect yourself from IRS scrutiny.
Table of Contents
The Research and Experimentation Tax Credit
Designed to encourage research and development across industries and foster innovation within the United States, the government enacted the R&E Tax Credit. Investing in innovation is critical to long-term economic growth, and by providing a tax credit, the government incentivizes businesses to research and experiment continuously.
The R&E Tax Credit can be carried back one year then forward for twenty years to help new and small businesses from reaping the full benefits. 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.
Related Link: What are Tax Incentives? A Beginner’s Guide
What Qualifies as a Qualified Research Activity?
The IRS requires that a research activity must pass a four-part test:
- The R&E activity must relate to a principle of physical science, biological science, engineering, or computer science.
- The activity must attempt to improve the functionality, performance, quality, or reliability of a new or existing component.
- The activity should attempt to eliminate the uncertainty of the product development or improvement.
- The activity must follow a process of experimentation that includes testing, modeling, simulating, trial and error, or an evaluation of alternatives.
Businesses don’t need to be inventing something completely new or groundbreaking in their industries to qualify for the credit, as long as they are designing or developing products or processes that are new to them.. And eligibility doesn’t depend on the success of the innovation.
What Types of Qualified Research Expenses (QRE) Count Toward the Credit?
A QRE is an expense incurred while performing a qualified research activity. QREs can be in-house research expenses and contract research expenses:
- In-house research expenses: Wages, supplies, and computer leasing expenses.
- Contract research expenses: 65% of payments to an outside person or organization or 75% of payments to a qualified research consortium.
Need help calculating your R&E Tax Credit? Learn more about our proven R&E Tax Credit services.
Related Link: Learn Your Tax Liability & How to Calculate It
How Much is the R&E Tax Credit?
The R&E Tax Credit can be claimed at federal and state levels, some states having varied percentages. To understand the precise percentages of the tax credit for your state, you’ll want to talk to an accounting expert.
Each year a business can claim either the regular or alternative simplified credit. They can also claim the basic and energy research each year where applicable. The tax credit can be categorized into four parts:
Regular Research Credit (RRC)
Designed to boost investment in R&D, the RRC allows 20% of qualified research expenses (QRE) from the current year over the base amount. The base amount is the historical percentage of QREs to gross receipts applied to the average gross receipts from the last four years.
Alternative Simplified Credit (ASC)
60% of businesses choose the ASC because it can be more generous than the regular credit. The ASC is 14% of the taxable year’s QREs, which is more than 50% of the average QRE from the previous three tax years. If the business didn’t have QREs in the previous years, it could claim 6% of the QREs for the current year. It also allows companies that lack historical documentation to leverage their recent and rolling base period to file for the ASC tax credit.
Basic Research Credit
Companies that pay non-profit organizations, like universities, to conduct basic research can claim a basic research credit. This credit is based on the percent of expenses above a base amount spent on advancing scientific knowledge not intended for commercial application. Because of the specific nature of this credit, you’ll want to document all expenses well and consult with your accountants about which expenses will count for eligibility.
Energy Research Credit
Companies that pay a non-profit organization to advance energy research can claim the energy research credit. This credit is a percentage of the total energy research expenses and has no base amount to qualify.
What Documents Do You Need to Claim the R&D Tax Credit?
R&D tax credits can be claimed for the current year and prior years as long as the business can provide documentation of their QREs. While some estimation for research is allowed, it is a best practice to evaluate and document all research activities and their expenses. You’ll want to have documentation of:
- General ledger expense detail
- Project lists
- Project notes
- Payroll records
- Lab results
- Supply Invoices
Each of these documents will strengthen your eligibility for the R&D Tax Credit.
Common Challenges Applying for the R&D Tax Credit
Some of the common challenges of applying for the R&D tax credit include:
- Increased scrutiny from the IRS if credit claims are substantial. This is why proper documentation is critical to making claims.
- Six to twelve month lead time for receiving refunds.
- High base amounts or decreasing QREs over time may shrink the size of your benefit.
Innovative Businesses Large and Small Should Claim the R&E Tax Credit
Whether you are a new start-up or an established enterprise that pursues continual innovation, you should take advantage of the R&E Tax Credit to alleviate your tax burden. You should carefully evaluate and document all research activities and expenses to claim maximum eligibility for the credit and as a defense against any IRS scrutiny. You should consult with your preferred tax agency to learn more about how you can leverage this tax credit.
Parachor Consulting has experienced tax professionals that can help you identify, evaluate, and document QREs to claim an R&E 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, we can help you maximize your tax credit eligibility.
Made a permanent tax credit in the Protecting Americans from Tax Hikes (PATH) Act of 2015, The Research and Experimentation Tax Credit allows businesses and individuals that are innovating, researching, and experimenting in some capacity to incorporate the credit into the tax-planning strategy. This especially benefits start-ups and small businesses.
Unfortunately, many businesses overlook this valuable tax credit because they don’t think they have expenses that will qualify. We’ll explain why you’ll want to claim the R&E Tax Credit, what qualifies as an expense, and how to protect yourself from IRS scrutiny.
The Research and Experimentation Tax Credit
Designed to encourage research and development across industries and foster innovation within the United States, the government enacted the R&E Tax Credit. Investing in innovation is critical to long-term economic growth, and by providing a tax credit, the government incentivizes businesses to research and experiment continuously.
The R&E Tax Credit can be carried back one year then forward for twenty years to help new and small businesses from reaping the full benefits. 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.
Related Link: What are Tax Incentives? A Beginner’s Guide
What Qualifies as a Qualified Research Activity?
The IRS requires that a research activity must pass a four-part test:
- The R&E activity must relate to a principle of physical science, biological science, engineering, or computer science.
- The activity must attempt to improve the functionality, performance, quality, or reliability of a new or existing component.
- The activity should attempt to eliminate the uncertainty of the product development or improvement.
- The activity must follow a process of experimentation that includes testing, modeling, simulating, trial and error, or an evaluation of alternatives.
Businesses don’t need to be inventing something completely new or groundbreaking in their industries to qualify for the credit, as long as they are designing or developing products or processes that are new to them.. And eligibility doesn’t depend on the success of the innovation.
What Types of Qualified Research Expenses (QRE) Count Toward the Credit?
A QRE is an expense incurred while performing a qualified research activity. QREs can be in-house research expenses and contract research expenses:
- In-house research expenses: Wages, supplies, and computer leasing expenses.
- Contract research expenses: 65% of payments to an outside person or organization or 75% of payments to a qualified research consortium.
Need help calculating your R&E Tax Credit? Learn more about our proven R&E Tax Credit services.
Related Link: Learn Your Tax Liability & How to Calculate It
How Much is the R&E Tax Credit?
The R&E Tax Credit can be claimed at federal and state levels, some states having varied percentages. To understand the precise percentages of the tax credit for your state, you’ll want to talk to an accounting expert.
Each year a business can claim either the regular or alternative simplified credit. They can also claim the basic and energy research each year where applicable. The tax credit can be categorized into four parts:
Regular Research Credit (RRC)
Designed to boost investment in R&D, the RRC allows 20% of qualified research expenses (QRE) from the current year over the base amount. The base amount is the historical percentage of QREs to gross receipts applied to the average gross receipts from the last four years.
Alternative Simplified Credit (ASC)
60% of businesses choose the ASC because it can be more generous than the regular credit. The ASC is 14% of the taxable year’s QREs, which is more than 50% of the average QRE from the previous three tax years. If the business didn’t have QREs in the previous years, it could claim 6% of the QREs for the current year. It also allows companies that lack historical documentation to leverage their recent and rolling base period to file for the ASC tax credit.
Basic Research Credit
Companies that pay non-profit organizations, like universities, to conduct basic research can claim a basic research credit. This credit is based on the percent of expenses above a base amount spent on advancing scientific knowledge not intended for commercial application. Because of the specific nature of this credit, you’ll want to document all expenses well and consult with your accountants about which expenses will count for eligibility.
Energy Research Credit
Companies that pay a non-profit organization to advance energy research can claim the energy research credit. This credit is a percentage of the total energy research expenses and has no base amount to qualify.
What Documents Do You Need to Claim the R&D Tax Credit?
R&D tax credits can be claimed for the current year and prior years as long as the business can provide documentation of their QREs. While some estimation for research is allowed, it is a best practice to evaluate and document all research activities and their expenses. You’ll want to have documentation of:
- General ledger expense detail
- Project lists
- Project notes
- Payroll records
- Lab results
- Supply Invoices
Each of these documents will strengthen your eligibility for the R&D Tax Credit.
Common Challenges Applying for the R&D Tax Credit
Some of the common challenges of applying for the R&D tax credit include:
- Increased scrutiny from the IRS if credit claims are substantial. This is why proper documentation is critical to making claims.
- Six to twelve month lead time for receiving refunds.
- High base amounts or decreasing QREs over time may shrink the size of your benefit.
Innovative Businesses Large and Small Should Claim the R&E Tax Credit
Whether you are a new start-up or an established enterprise that pursues continual innovation, you should take advantage of the R&E Tax Credit to alleviate your tax burden. You should carefully evaluate and document all research activities and expenses to claim maximum eligibility for the credit and as a defense against any IRS scrutiny. You should consult with your preferred tax agency to learn more about how you can leverage this tax credit.
Parachor Consulting has experienced tax professionals that can help you identify, evaluate, and document QREs to claim an R&E 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, we can help you maximize your tax credit eligibility.
Related Link: How to Offset AMT with R&D Credits in 2022
