Also known as the research and experimentation tax credit, the research and development (R&D) tax credit under section 41 of the Internal Revenue Code (IRC) is a general business tax credit that helps U.S. businesses significantly reduce their tax liability.
Businesses that incur expenses for conducting research and development activities in the U.S. may be eligible to apply for the R&D tax credit if they meet the qualifying criteria stipulated in section 41 of the IRC. Eligible small businesses can also use up to $250,000.00 of their R&D tax credit to offset payroll taxes.
Qualifying expenses include the wages paid to employees who performed qualifying services, supplies used for conducting research, contract research expenses, certain amounts paid to energy consortia, research payments to qualified organizations, and the cost of renting or leasing computers used to perform qualified research activities.
Qualifying R&D activities:
Research that is technological in nature.
The testing of a product or process must rely on principles of the natural sciences.
Research that attempts to discover new information or resolve an uncertainty.
The information and insight gained from the research should be useful to the development or improvement of a product or process.
Research that involves testing or experimenting.
Activities must be part of a process of experimentation, such as modeling, trial and error, or simulations, to achieve results.
Research that has a qualifying purpose.
The purpose of the research must relate to a new or improved function, performance, reliability or quality.
R&D activities that do not qualify:
- Research conducted after the beginning of commercial production of a business component.
- Research adapting an existing business component to a particular customer’s need.
- Research related to the duplication of an existing business component.
- Surveys, studies, or routine testing for quality control.
- Research relating to certain computer software developed for internal use.
- Research conducted outside the United States, Puerto Rico, or a U.S. possession.
- Research in the social sciences, arts, or humanities.
- Research funded by another person, grant, contract, or government entity.
How to claim the R&D tax credit:
Assess whether any of your business's projects, products, and processes qualify. Examine whether any activities meet the qualifying criteria of being technological in nature, involve experimentation, constitute an attempt to eliminate uncertainty, and are being performed for a qualifying purpose, such as quality improvement.
Identify and track qualifying expenses. Make sure that all qualifying expenses, such as the wages paid to employees who performed qualifying services, supplies used for conducting research, and contract research expenses, are documented separately.
Collect supporting documentation. Besides financial, tax, and payroll records, you should also gather any documentation that can show the connection between the expenses and activities, as well as demonstrate the nature of the activities. Such documentation might include time-tracking records, project development notes, testing reports, email communication, patents, and more.
Submit your R&D tax credit application with your tax return. Complete Form 6765 "Credit for Increasing Research Activities". If you want to use some of your R&D tax credit to offset payroll, you must elect payroll tax credit in section D of the form. The completed form must be attached to your tax return. See detailed instructions for Form 6765 here.
If you elected the payroll tax credit on Form 6765, you must also complete and submit Form 8974 "Qualified Small Payroll Tax for Increasing Research Activities". Once completed, Form 8974 must also be attached to your tax return. Find detailed instructions for Form 8974 here.
Which expenses qualify for the R&D tax credit?
Certain expenses, including wages, the cost of supplies, payments to qualified organizations, and rental or lease costs of computers, incurred while conducting research activities that are technological in nature, involve experimentation, attempt to eliminate uncertainty, and are being performed for a qualified purpose, qualify for the R&D tax credit.
What is R&D tax credit?
The R&D tax credit is a general business tax credit that rewards U.S. businesses investing in qualifying research and development activities.
What are qualified research and development expenses?
- Certain amounts paid to energy consortia.
- Research payments to qualified organizations.
- Wages for performing qualified research activities.
- Cost of supplies.
- Contract research expenses.
- Rental or lease costs of computers.
How does the R&D tax credit work?
Businesses that incur expenses for performing research and development activities that meet certain qualifying criteria can apply the R&D tax credit, which can significantly reduce their tax liability. Small businesses can also use their R&D tax credits to offset payroll taxes.
Are R&D tax credits taxable?
No, but R&D tax credits can help reduce a business's tax liability.
Are R&D credits refundable?
No, the R&D tax credit serves to reduce a business's tax liability. Eligible small businesses can also use the R&D tax credit to offset payroll taxes.
Does software development qualify for the R&D tax credit?
Yes, software development can qualify for the R&D tax credit. However, be sure to check that your software development activities meet the qualifying criteria set out in section 41 of the Internal Revenue Code.
How are research and development credits calculated?
Form 6765 is used to calculate the R&D tax credit, providing two main methods for doing so. Regular credit is calculated as 20% of the current year qualified research expenses in excess of a base amount. Alternate simplified credit equals 14% of current year qualified research expenses less 50% of the average research expenses of the three preceding tax years.
How far back can you claim R&D tax credits?
Generally, the R&D tax credit claim time limit is 2 years from the end of your accounting period. However, any tax credits that cannot be used immediately may be carried forward for up to 20 years.