One of the surest ways to expand your business is to create new products or services or enhance existing products. However, the time and money that is necessary to perform research and development operations can be a burden that might fall flat in terms of return on investment.
Considering that investments in new technologies, new products, and services are critical to the economic health of the United States, it is in the government’s interest to promote these activities. This is where RD tax credits play a large part. The RD tax credit is usually cited as one of the most beneficial credits for businesses looking to save money on taxes. Regrettably, as a result of a combination of misconceptions and a relative lack of knowledge of facts, RD tax credits are grossly underutilized.
This article aims to broaden your knowledge with RD tax credits, how this works, and whom it benefits.
What are RD Tax Credits?
“The Research and Development Tax Credit,” alternatively termed as the “Credit for Increasing Research Activities,” is a tax credit for businesses that assists companies that have invested in research and development in recouping some of their costs. The RD tax credit was initially implemented as a temporary measure to promote economic activity in 1981 but has subsequently become a permanent item of the tax code.
Is your business eligible for RD Tax Credits?
If your business made an investment in research and development in the previous year, it is very certainly qualified for the credit. While it is widely believed that only big businesses qualify for the credit, the RD tax credits are widely available for businesses of different sizes and across a wide range of industries. To be qualified, your business must have incurred what the IRS refers to as the Qualified Research Expenditures or QREs.
QRE’s, in principle, is if your business has made an attempt to build innovative new products or processes or has worked hard to improve some existing products or processes, you are eligible to qualify for the RD tax credits.
Using RD Tax Credits for Your Business
If your business is eligible for RD tax credits, you will have some flexibility in determining when and how to use them. For the vast majority of businesses that are now financially successful, RD tax credits will be applied to the income tax liabilities of the business. The credit is often used to cover payroll obligations for small businesses, like startups, to the business’s income tax liabilities. For small businesses, such as startups, the credit is typically utilized to offset payroll liabilities.
We have named a few basic ways RD tax credits are used to optimize their advantage to your company below:
- Recouping 5% to 15% of the funds that were spent on qualified expenses
The refund amount varies depending on the nature of the business, but in its most basic form, RD tax credits cover between 5% and 15% of qualified research costs. Therefore, if your business invests $100,000 for expenses invalid research, you can claim between $5,000 and $15,000.
- Offsetting payroll taxes with the credit
One of the most typical ways for small businesses to claim the RD tax credits is to utilize them to offset payroll taxes. This can be very beneficial to your business. To be qualified, all the gross receipts for the questioned year must be less than $5 million, and they cannot be more than five years.
If your business matches these criteria, you may use RD tax credits to offset payroll taxes up to $250,000. By selecting this approach as an option when completing your income tax return, you will apply the RD tax credits to your payroll taxes. If you discover that you are qualified for the credit for prior years, you can use the credit’s surplus value to be able to offset some of your liabilities for the income tax.
- Reflecting on the past and anticipating the future
If you did not claim the credit in prior years but were still eligible, you may still claim it this year. It is possible to modify your income tax return to include the RD tax credits, which would result in a refund that you could claim for that year.
Certain businesses who are not yet able to achieve profitability but still continue to incur research and development expenses may feel as if they are not reaping the full benefit of the credit. Fortunately, businesses can carry forward the unused credit amounts for up to 20 years.
What expenses do you have that qualify for RD Tax Credits?
Generally, RD tax credits are available for expenses incurred to develop a new product, innovative technologies, or services or improve existing products, technologies, or services. To be more precise, the following activities typically qualify:
- Processes of engineering that include design, data collecting and analysis, and testing.
- Improving the technologies that power your business, such as using the software.
- New products prototyping.
- Development processes (even if they are incomplete).
- Creating patents.
According to the guidelines of the IRS, there are four broad categories of R&D costs that will qualify as lawful expenses:
Materials used in the RD process are allowable as expenses, but they cannot be general administrative supplies that are being utilized in the course of normal operations.
Salaries that are paid to employees who participated in, assisted with, or oversaw research procedures may be claimed as expenses.
- Computer-related services.
If you rented computers or engaged cloud service providers to conduct research or to host software in development, then you can count this as an expense.
Even if certain subcontractors’ fees are incurred, contract research may still qualify for RD tax credits as long as you retain major rights to the results.
How much money can I anticipate receiving as a result of RD Tax Credits?
The federal RD tax credit is normally worth up to 15% of qualified research expenses or up to $250,000 in the yearly payroll costs, which means that successfully applying the R&D tax credit could possibly save your business millions of dollars over multiple years. More specifically, businesses will often obtain a credit of between 5% and 15% of the entire amount of expenses that match the IRS’s conditions.
Additionally, the majority of states in the United States have their own versions of RD tax credits, which can boost the value of this deduction for qualifying businesses.