A Research and Development (R&D) tax credit is a financial incentive offered by the federal government which rewards companies that use scientific principles to make improvements to their industry or business.
Having originally been introduced in 1981, the Research and Development Credit was made permanent in 2015. The same legislation that made the R&D tax credit permanent also made significant changes to the credit, which include the following provisions:
- Businesses may be able to use the credits to offset their payroll taxes, which are part of the Federal Insurance Contributions Act (FICA) for tax years beginning after December 31, 2017.
- If a company owes Alternative Minimum Tax, it can now use the credit to offset it for tax years beginning after December 31, 2015.
Now that the first tax year for the provision behind us, it is clear that the credits can significantly reduce tax expenses for small and large businesses alike.
How do Companies Qualify to use the R&D Tax Credit Against Payroll Taxes?
In order to qualify to use the R&D tax credit against payroll taxes, you need to be a business that meets the following criteria:
- Your company’s annual gross receipts in the year that you are claiming the credits should not exceed $5 million. Gross receipts include your total sales and any income from other sources, such as interest on investments.
- Your company shouldn’t have any gross receipts in any tax year prior to the five-year period from the year in which you are claiming the credits. For instance, if you are claiming the credits in tax year 2017, you shouldn’t have any gross receipts in tax year 2013 or tax years preceding 2013.
It’s also important to note that, if your business meets this criteria, your specific research and development project must also meet its own additional requirements defined by the IRS in order to qualify for the R&D tax credit.
Benefits of the Research and Development Tax Credit
The goal of the R&D tax credit is to help keep U.S. businesses more competitive in the global marketplace. If you are a small or medium enterprise, the R&D tax credit can directly benefit your business in many ways, including:
- Improved cash flow – The R&D tax credit can be carried forward for up to 20 years, allowing to the option to use credits in a lean quarter for better cash flow.
- Competitiveness – The R&D tax credit was implemented to directly fuel innovation in the local economy. This incentive can benefit your business by the financial reward in addition to the advantageous results of your company’s innovation efforts in comparison to your competition.
- Lower payroll costs – The R&D tax credit can directly reduce your payroll costs without reducing your staff or their salaries.
A common misconception surrounding the Research and Development tax credit is it can be used only by companies inventing something new. The fact is, it can be used by eligible organizations that are working on product improvement or the improvement of processes. For instance, manufacturing companies are excellent candidates for utilizing the R&D tax credit because they often have general research expenses associated with their products and operations.
In addition to the federal Research and Development tax credit, several U.S. states offer research tax credits as well. The definitions and eligibility requirements of these credits will vary by state.
If your company has made improvements to its products, processes or software, you may qualify for the R&D tax credit, but the federal government also offers many other tax credits that may benefit your business. Warren Averett’s Quali-Finder™ is a diagnostic tool that identifies tax credits and incentives that your business may be overlooking. You can learn more about Quali-Finder and begin the process here.