Research and Development (R&D) tax credits might offer dollar-for-dollar reduction in federal income tax liability, but how easy is it to claim them through Form 6765? While IRS instructions are available, these often make references to the relevant sections of the Internal Revenue Code. So unless you already have technical knowledge, the IRS guidance can prove difficult and time consuming to follow.
This is why we developed a beginner’s guide for Form 6765—to help you figure it out without the technical jargon.
Understanding Form 6765’s Purpose
A good place to start is to identify the form’s purpose, as this sheds light on the information and documentation you will need to provide.
Essentially, Form 6765 is used to calculate and claim the R&D tax credits you are entitled to for increasing research and experimentation activities.
Additionally, it allows you to communicate how you would like to apply these credits. For example, if you are an eligible small business, you can use them to offset both your regular and alternative minimum tax. If you are a qualified small business, you can choose to apply them against payroll taxes. Finally, if you are a member of a group of companies, you can report and substantiate your portion of the group’s R&D credits.
With this in mind, let’s take a look at the four sections that make up Form 6765.
Working out your tax credits – Sections A and B of Form 6765
Now, a common area of confusion concerns the method to use when calculating your R&D tax credits. You can use either the Regular method and fill out Section A, or the Alternative Simplified Credit method and complete Section B.
One way to decide on the best approach is to figure out your entitlement under both methods, and then choose the one that is more advantageous.
In terms of how these approaches differ, the regular research credit is 20 percent of all qualifying expenditures for the current year that exceed a specified base amount. Working out the base amount can be a potential pain point, as it may involve detailed calculations—depending on whether you are a start-up or well-established business.
The alternative method, on the other hand, begins with finding the difference between the amount of qualifying expenditure in the current year and 50 percent of the average qualifying expenditure for the preceding three tax years. This difference is then multiplied by 14 percent to arrive at your R&D credit.
Identifying Eligible Research Expenses
Calculating your tax credits in Section A or B involves establishing whether expenses relate to eligible R&D activities. Qualifying activities are primarily those that meet the requirements of the four-part test , set out by the IRS.
Form 6765 allows you to claim three types of expenses, including salaries, supplies (such as materials and computer rentals) and contracted research. However, bear in mind you will need to support these claims with sufficient documentation.
In practice, a starting point may be to identify potential qualifying research expenses that make up the R&D cost in your financial accounting system. However, this is only a starting point, and more work will be needed.
Taking a reduced credit
At the end of both Section A and B, you have the option of electing to take a reduced credit. Making the election reduces the amount of the R&D tax credit but eliminates the need to make an unfavorable adjustment to taxable income. Also, making the election may simplify the preparation of state tax returns. There can be other reasons for making this election. All factors being equal, a corporation subject to the top corporate tax rate pays the same tax whether or not it makes the election.
Current year credit – Section C of Form 6765
Once you have quantified your R&D credit for the current year, Section C directs you to other forms and schedules where you will need to report this figure given your business structure.
Claiming payroll tax offset – Section D of Form 6765
The last part of the form allows a qualified small business to use some or all of your R&D credits to offset payroll tax obligations, up to a maximum of $250,000. The amount you nominate in this section should then be replicated on Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. The payroll tax offset will become available quarterly after the filing of your federal income tax return.
Additional Things to Know
Form 6765 should be filed with your company’s income tax return no later than the extended due date of that year’s tax return.
R&D credits is a complex area to navigate. To ensure your business remains compliant while taking full advantage of tax savings opportunities, connect with a Warren Averett advisor or begin the Quali-Finder® process.