The Research & Development (R&D) Tax Credit is a government incentive available to companies that create or improve a product or process used by their business. The dollar-for-dollar credit offsets your income and/or payroll tax liability. Many businesses are unaware that their daily operations could qualify for a dollar-for-dollar tax credit, irrespective of industry or company size. Additionally, most states offer an R&D credit that can supplement the federal R&D credit, and qualifying businesses can claim both!
Leyton has a dedicated team of Tax experts that can provide insight to ensure you are not missing out and help your companies businesses growth!
We work with several tax professionals and have addressed our most frequently asked R&D questions:
1. Do you have an example of an industry that would not qualify?
Any company whose product or service is not scientific in nature (I.e. not ‘technical’) such as market research, marketing, law, accounting, 3rd party re-sellers, HR and professional services, etc. Secondly, if a company has been doing its core work the same way for the past several years with no updates, changes, or attempts at improving, then it in essence is not doing R&D. To perform R&D is to strive as a company to produce a new or improved product or service, through methods based on science.
2. Does claiming R&D tax credit elevate the risk of an IRS audit for the business?
No, claiming the R&D Tax Credit does not increase your risk of audit; the chance of audit is increased slightly (1 – 3% Federal average) upon amending a return – regardless of the reason. This slight risk is inherent in amending for a refund due to claiming the credit in a past year vs. On a timely-filed return.
3. Can you specify the 5 year in business rule? Can they only claim if been in business 5 years or less?
That is in regard to the Payroll Tax Credit election. The business must have generated gross receipts for the past 5 or less years in order to qualify for this segment of the tax credit. A qualified business can claim the R&D Tax credit, which offsets tax liability, regardless of how long it’s been in existence.
4. What are the new requirements for amortization of R&D costs? How does this reduce current benefits?
The current law – in effect for Tax Year 2022 and forward – is that companies must capitalize and amortize its research and development expenses over a 5 year period, using the mid-year convention. This is regardless of whether a company also claims the R&D credit. The R&D credit calculation is not affected by these changes. The rule change is enacted through the Tax Cuts and Jobs Act (TCJA) of 2017.
5. Can you explain more about the 3-year lookback? I thought you need to only provide expenses from that tax year on a certain year return.
The Credit can be claimed up to 3 years prior to the current year’s filing. This is depending on the oldest year’s statute of limitations. Tax returns have a 3-year period they can be amended, based on their initial filing date. That means currently, tax year 2019 is likely the earliest year that can be amended to claim the credit.
Part of the calculation for any year entails 4 ‘base years’ worth of info per the tax returns, including expenses claimed and gross receipts. That means for a credit claim for tax years 2019 – 2022, for instance, it would also be necessary to provide 2015 – 2018 tax returns for an accurate calculation.
6. Do we have any restriction when the expenses are outsourced? Does the outsource has to be within the US?
Yes, any cost claimed towards the R&D Credit must have been derived in the U.S. That means for employees and contractors, they must have been located in the U.S. or U.S. territories in order for those payments to count as eligible expenses towards the credit.
7. I just want to confirm that these are unfunded costs, correct? If they got a grant for the work, those expenses would not qualify.
Correct, we cannot include any expenses for the credit covered by grants.
8. If this is the first year the company is operating, do you use zero as average gross receipt when calculating the credit with traditional method? Or do you have to use ASM?
You could still do either calculation method. Under traditional, yes the average gross receipts line would be $0 and the Fixed Base percentage would be 3%. Making it likely that Traditional would be more optimal, but you could use the ASC Method. Under ASC, average prior 3 years of qualified expenses would also be $0.
9. Can I get the credit if we use outside services to help us create the product?
Yes, sub-contracted expenses can be included at 65% of their cost incurred by the company. (I.e. a contractor paid $100k would have $65k in eligible expenses to potentially be qualified towards the credit).
10. What percent of the credit is your fee?
Let’s talk about it!
