Many small and midsize businesses affected by COVID-19 are struggling to maintain their cashflow, operational capabilities, and internal research and development activities. The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided some financial relief to these businesses affected by COVID-19 through emergency grants, retention tax credits, and forgivable loans that only provide temporary help with cashflow, and not long-term solutions.
Are you aware that research and development tax credits can significantly reduce income tax liabilities?
That’s right! Research tax credits are another valuable source of cash for many small and midsize businesses. And research credits are permanent that can be claimed year after year.
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What is the R&D Tax Credit?
The R&D Tax credit is a valuable business credit that is intended to promote technological innovation and create jobs. Federal and state R&D tax credits can amount to as much as 20% of the costs incurred in developing and improving new and existing products, processes, and software. Unlike a tax deduction — the R&D tax credit is a dollar-for-dollar credit against taxes owed or already paid.
Qualifying Research Activities (QRAs)
QRAs relate to efforts undertaken to develop new products, enhance existing products, and to develop or improve processes or software. In order to qualify for the R&D tax credit, the qualifying research activities must satisfy the Four Tests ascribed by the IRS. In addition, the company carrying out the work must bear the financial risk.
Qualifying Expenses (QREs)
There are four general types of research-related expenses that you can claim:
- Wages – wages paid to employees conducting, supervising, or directly supporting R&D activities.
- Supply Expenses – amounts paid or incurred for supplies used in R&D activities
- Contract Expenses – U.S. based third-party contractors participating in R&D activities
- Leased Computer Expenses – cloud service providers used in software development
Payroll Tax Credit for Small Businesses
In addition to offsetting tax liabilities, the Protecting Americans from Tax Hikes Act of 2015 (The PATH Act) created an opportunity for qualified small businesses to use federal R&D tax credits to offset all or a portion of the employer portion of FICA. In any given year, a company can apply up to $250,000 of their tax credits. Note, the election can only be made for five tax years.
For this purpose, a qualified small business is a taxpayer who:
- Did not have gross receipts for any tax year preceding the five-tax-year period ending with the credit year.
- Has less than $5 million in gross receipts in the current year
- Has qualifying research activities and expenditures
- The R&D tax credit benefits businesses by helping them keep more of their profits while also improving their products and technology.
- R&D tax credits allow qualified businesses to deduct the cost of qualified research and innovation from their taxable income.
- Qualified research must be technological, involve uncertainty and experimentation, and involve the development of new products, processes or software.
- Qualified research does not have to be successful.
- R&D tax credits are claimed on federal and state returns and are refundable when claimed You generally have three years to file an amended a return.
How to Claim R&D Tax Credits
To take advantage of these favorable federal and state tax incentives documentation is key. Start by evaluating all your company’s activities for potential eligibility, then begin gathering documentation and tracking expenses that establishes a clear and concise connection between qualified projects and expenses related to those projects to substantiate your claim. The IRS requires a nexus of research costs to research activities.
The R&D Study – We Can Help!
Has COVID-19 affected your business? Intrepid Advisors has been providing federal and state research tax credit services to hundreds of small and mid-market companies for over 30 years. We’ll guide you in identifying your company’s qualifying development activities and expenses and our staff of accountants and experienced engineers will prepare the complicated calculations and detailed supporting technical documentation so you can focus on the demands of your business.