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The R&D Tax Credit, officially titled the Credit for Increasing Research Activities, is a permanent dollar for dollar offset to a company’s tax liability for performing activities that satisfy the IRS’ criteria. The credit was first enacted in 1981 and has since been made permanent in 2015, allowing for companies to carry any unused credit forward for up to 20 years. The R&D Tax Credit, which is found under Section 41 of the IRS code, is used to incentivize and encourage businesses to invest in innovation and development within the US. If you have any questions for our experts regarding Form 6765 or the R&D Tax Credit, schedule a call!
What is IRS Form 6765?
Form 6765 is the form used to file and claim the Credit for Increasing Research Activities on a company’s yearly income tax return. Form 6765 is broken into 4 sections:
Section A – Regular Credit
Section B – Alternative Simplified Credit
Section C – Current Year Credit
Section D – Qualified Small Business Payroll Tax Election and Payroll Tax Credit
For sections A and B, only one is ultimately completed. These are the two different methodologies for calculating the R&D credit, and companies are permitted to use the method that yields the larger credit. Therefore, it is recommended companies calculate the credit using both methodologies, and only complete Form 6765 with the more beneficial of the two.
Section C is always completed, however, it does not require calculations of it’s own as it uses information readily available in other areas.
Section D is only used if a company qualifies as a Small Business and is eligible for the Payroll Tax Credit. The credit calculation remains the same and is completed on Section A or B, however, Section D allows for a company to elect to treat all, or a portion of, the identified credit as an offset to their quarterly payroll tax liability. Leyton’s latest payroll credit article can be found here.
Who Qualifies for the R&D Tax Credit?
The R&D Tax Credit is available to a business of any size or industry so long as they engage in activities to develop a new or improved product, process, formula, technique, invention, or software. The IRS sets forth a 4-Part Test to determine if the activities conducted qualify as research activities. These tests are titled as follows:
What types of expenses can be included in the calculation of the R&D tax credit on Form 6765?
Similar to the 4-Part Test for activity qualification, the IRS identified 4 cost categories that are permitted to be included as Qualified Research Expenditures (QREs). These include:
1. Salaries & Wages
a. Wages paid to employees for conducting, directly supervising, or directly supporting the qualified research activities.
2. Contract Research Expenses
a. Similar to wages, these expenses include payments to a third party for conducting, directly supervising, or directly supporting the qualified research activities.
Additionally, the IRS implemented rules to determine if third party payments are considered qualified expenses or funded research, which is not permitted to be included. To be included as QREs, companies must:
1. Enter into an agreement prior to the performance of the research;
2. Maintain substantial rights to the research performed; and
3. Bear the economic risk of the development
3. Supplies and Materials
a. Any tangible property other than land or improvements to land, and property of a character subject to the allowance for depreciation. In other words, supplies and materials refer to consumable goods rather than depreciable assets.
4. Leased or Rental External Computing
a. While initially implemented when companies would lease computers, nowadays this refers to expenses used during development, such as web hosting expenses, but does not include any off the shelf software products.
What documentation is required to support a claim made on Form 6765?
When filing for the R&D Tax Credit, the only information provided to the IRS regarding the qualified expenditures is the Form 6765, which outlines the total of each QRE cost category. While additional documentation is not required to be provided, the IRS does require companies to retain records to substantiate the eligible expenses. These often include employee W2s, Forms 1099s for external contractors, invoices for supplies & materials, etc. These documents should already be retained and used for yearly financial document preparation and tax filings, so often require little to no additional efforts. Additionally, companies should retain records as to the activities being conducted and considered for the R&D credit such as time tracking, technical drawings and specifications, etc.
When claiming the R&D credit on an amended return, the IRS has recently altered the filing requirements. In addition to the Form 6765, the IRS requires supplementary information to be provided to further substantiate the qualified activities and related expenses. This additional information includes:
1. “Identify all the business components to which the Section 41 research credit claim relates to for that year.
2. For each business component, identify all research activities performed and
3. Name the individuals who performed each research activity,
4. As well as the information each individual sought to discover.
5. Provide the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year.”
Although this requirement was recently implemented, this information has historically been gathered by Leyton as it’s needed to ensure a company’s qualification for the credit. Now, Leyton provides this information for you in an easy-to-read format that suffices the IRS requests.
*The name of individuals who performed each research activity and the information each individual sought to discover are no longer required as of June 18, 2024. However, this information may be asked for if the IRS selects the amended return for an exam so it is important to have this information available if requested.*
Best Practices
Consultant with a tax professional! Here at Leyton, we work hand-in-hand with our client’s CPAs to ensure the client’s best interests are directly at the forefront. We also have a fantastic partnership program for CPAs and Tax Professionals and can leverage our network for all of your accounting questions. With our multiple services at Leyton, we’re always looking to ensure our clients are taking advantage of all available tax credits and incentives. Schedule a meeting with us today to see how we can help!
