If you want to grow your business, you have to constantly be putting out new products, developing new technologies, systems, and even industries. Growth is essential to the success of any business, and to the economy. But in order to continue growing, the economy needs innovation and innovation requires expensive and exhaustive research and development (R&D). in order to encourage companies to invest more on research and development, the R&D tax credit software was created.
R&D Tax Credit
As we have mentioned earlier, innovation is essential to growing businesses and economies. However, it can be a very expensive and exhausting endeavor to pursue. Many companies conduct expensive research and development projects, fail with no return on investment (ROI), or have to take years and multiple stages of development before it even becomes profitable. The high costs can easily discourage or scare businesses from investing in R&D. Fortunately, the R&D tax credit was created so that businesses can get incentives for continuing their efforts in innovation.
What is the Research and Development (R&D) Tax Credit Program?
The Research and Development tax credit, also known as the R&D Tax credit, or Research and Experimentation Tax Credit, is designed to stimulate economic growth by encouraging businesses and business owners to invest in research, innovation and developing new technologies.
The R&D tax credit was first introduced in 1981 and was renewed regularly over the following decades. In 2015, it was permanently extended after President Barack Obama signed the PATH Act. Several of its provisions were extended as well. In 2016, the R&D tax credit may offset the alternative minimum tax. This means that startup businesses can use the R&D tax credit against payroll taxes. In 2022, the Tax Cuts and Jobs Act (TCJA) put into effect additional changes to the tax credit.
Tax credits allows taxpayers, which can be a company, to counteract or offset the value of that credit against the tax liability of their business. The IRS explains that the R&D tax credit is used for “expenses paid or incurred for qualified research.”
Benefits of the R&D Tax Credit
Overall, awarding businesses tax credits for pursuing research and development is considered a huge help to the overall economy by stimulating growth and innovation. But some business groups claim that these benefits may be overlooked under the TCJA’s new amortization rules.
For 2022, the TCJA will require businesses to amortize their US-based R&D expenditures over five years, instead of just deducting them right away. According to an analysis by the Tax Foundation, canceling the amortization rules will be beneficial to both businesses and workers by increasing economic output and wages. This will result to the creation of around 19,500 jobs.
But businesses that claim R&D credit tax credit benefit from reduced taxes. This makes it a cash source for many small-time and mid-sized businesses.
The R&D tax credit software does the following:
- Lessens your federal and state tax liabilities for the current years and in the future
- Helps improve your business’ market value and cash flow
- Decreases your company’s effective tax rate
- You get to keep more of your profits
How Do You Know if You Qualify for the R&D Tax Credit?
The IRS changed the language used to determine which companies can claim R&D tax credits. Currently, most companies that test products, engage in data science, use data analysis, employ engineers, and/or outsource product research can apply for the credit.
However, here’s the catch: your business must prove that it uses a component of hard science in its research to claim the credit.
If your business is in the food industry, or if you work as an accountant, you cannot claim the credit even if you do research or test new products. If your business is involved in the “humanities” and you try to claim R&D tax credit for it, it’s highly likely that the IRS will audit you.
R&D Tax Credit Software Calculations
There are two ways for businesses to calculate the federal R&D tax credit: the regular method and the alternative simplified credit method. A lot of R&D tax credit software calculate available credits using both methods which greatly benefit businesses. Businesses can see which method yields the larger credit in any given tax year.
Some small businesses may also choose to claim the federal R&D tax credit against payroll taxes instead of income tax. This is the reason why a qualified small business is one that has less than $5 million in gross receipts for the tax year, without gross receipts for any tax year prior the five tax years ending with the current tax year being calculated. The business to claim the payroll tax credit election using an originally filed federal income tax return.
Calculating the R&D Tax Credit Using the Traditional Method
Calculating the R&D tax credit using the traditional method is done based on a 20% of a company’s current year QREs over a base amount. But first, the fix-based percentage must be acquired by dividing the QREs for tax years during a base period by the gross receipts from the same period. You then multiply the fixed-base percentage by the business’ average annual gross receipts for the four tax years before the year wherein the credit is being calculated. The result is the base amount.
Note: When you calculate these, the fixed-based percentage must not go over 16% and the base amount must not be less than 50% of the current year’s QREs.
Steps to Calculate the R&D Tax Credit with the Traditional Method
- Get the current year’s total QREs
- Find out the aggregate QREs over a base period
- Divide the aggregate QREs by the aggregate gross receipts over the same period so you can find out what the fixed-base percentage is
- Then you calculate the lesser of the fixed-base percentage or 16%
- Next, you multiply the fixed-base percentage using the average annual gross receipts from the past four years to find out what the base amount is
- Then you take the greater of the base amount and calculate it at 50% of the current year’s QREs
- Subtract the minimum base amount from the QREs of the current year
- Lastly, multiply the result by 20%
