Qualified software companies still have time to file a Research & Development (R&D) Tax Credit claim with their 2020 tax return by the March or April 15th deadlines.
Software companies are constantly innovating to introduce new or improved products to keep consumers engaged in an industry with rapidly changing trends. The high level of R&D involved in software design and development processes make companies in this sector ideal candidates to claim the R&D Tax Credit.
The R&D Tax Credit is a government incentive that rewards innovative companies either developing or improving their products by allowing them to recapture a portion of the investment in qualified R&D to offset payroll and/or corporate tax liability. There are two versions of the credit that software companies can claim depending on their eligibility:
The R&D Tax Credit allows companies to reduce their income tax liability in the current tax year, and potentially receive a cash refund for taxes paid in the last three (3) years. If there is no income tax liability the credit can be carried forward for up to 20 years. Many states have implemented their own version of the R&D Credit, and qualifying companies can claim both!
The Payroll Tax Credit is a Federal incentive that allows qualifying small businesses and startups to reduce a portion of the company’s share of FICA payroll tax liability, improving cash flow at a critical time for small businesses.
To be a qualified small business, an eligible entity must have less than $5 million in gross receipts over a five-year period and no gross receipts before the five-year period ending with the tax year. The payroll tax credit is limited to $250,000 each year and can only be elected up to five years. As a startup continues to grow and begins exceeding these additional criteria, it can claim the traditional version of the R&D Tax Credit to reduce future income tax liability.
Given the iterative software development process, there is almost always some R&D happening in the software industry. Here are a few examples:
Qualifying costs are the expenses incurred in performing the qualifying activities. Potentially qualifying R&D expenses include:
Wages: You can capture a percentage of your W2 employees’ salaries based on how much time they spend doing qualified R&D each year. Software developers are your core R&D employees so they will likely have the highest time spent on qualifying activity, but others in supervising or supporting positions may also be spending time on R&D.
Contracted Costs: Many companies hire contractors to assist with the R&D efforts and you can recapture up to 65% of the contracted R&D expenses.
Cloud Computing: Cloud computing server, platform, or SaaS software application costs can be included in the credit calculation.
Supplies: Any raw materials or supplies used or consumed during the R&D efforts may also be included.
As a general rule, a higher investment in R&D will yield a higher R&D Credit, especially if the level of R&D is increasing year after year.. The actual credit is dependent on a number of factors, but you can expect to receive somewhere between 7-10% of your total investment back as the Federal R&D Credit. Most, but not all, states also offer a credit to incentive innovation so there could be additional tax savings on the state-level.
Are you ready to start claiming? Leyton’s dedicated Software and Tax Consultants can help you maximize your R&D claim. We work with your CPA to ensure that your business is not leaving unclaimed money on the table.
Schedule a free consultation today with our R&D Tax Credit experts to determine your eligibility for the credit.
Founded in 1997, Leyton is a global innovation funding consultancy dedicated to helping our clients improve their business performance. In the US, our specific expertise is in optimization of Federal and State Research & Development (R&D) Tax Credits. As a business, we want to help unleash our clients potential and be a strategic partner in their evolution and growth.
2020 wasn’t a great year for many, but if you are looking for ways to optimize cash flow for...Insight - February 26, 2021
Assisted Reproductive Technology (ART) has gained tremendous growth since the successful birth of...Insight - January 5, 2021
In 2015, when the Protecting Americans from Tax Hikes (PATH) Act was passed to stimulate the...Insight - August 26, 2020