This past week I reviewed R & D tax credits with a couple of new clients. R & D (research & development). I’ll cut right to the chase.
They were leaving tens of thousands of dollars on the table. EACH.
And when I see a couple of people making the same mistake, I have to talk about it.
At the end of this blog, I’ll tell you the result and what we did about the problem.
The Good Thing About R & D Tax Credits
A tax credit goes directly against the tax you pay. A tax deduction reduces your income and the amount your tax goes down is based on your tax rate.
Tax deductions are good. Tax credits are way better.
R & D tax credits are calculated as somewhere between 12 – 16% of the expense. Plus, you will have the tax deductions.
It’s all perfectly legal. In fact, the government has recently made it even easier to get R & D tax credits.
What Counts As R & D?
In order to count as R & D an expense must pass a 4-part test:
1.Qualified purpose. The purpose of the activity is to improve the functionality, performance, reliability, or quality of a product, process, software, technique, invention or formula that is intended to be used in the taxpayer’s business or held for sale, lease or license (component).
2.echnological uncertainty. The taxpayer encounters uncertainty regarding whether it can or how it should develop the component, or regarding the component’s appropriate design.
3.Process of experimentation. To eliminate the uncertainty, the taxpayer evaluates alternatives through modeling, simulation, systematic trial and error, or other methods.
4.Technological in nature. The success or failure of the evaluative process is determined by the principles of engineering, physics, chemistry, biology, computer science, or similar natural or “hard” science, as opposed to principles of, e.g., economics, social sciences generally.
What Expenses Qualify For R & D?
Taxable wages for employees who perform or directly supervise or support qualified activities.
Cost of supplies used in qualified activities, including extraordinary utilities, excluding capital items or general administrative supplies.
65%-100% of contract research expenses for qualified activities, provided the taxpayer retain substantial rights to the activity’s results and must pay the contractor whether it succeeds or fails.
Rental or lease costs of computers used in qualified activities, e.g., payments to cloud service providers (CSPs) for the cost of renting server space to develop or improve a component.
How to Get Ready for R & D Tax Credits
Put a plan together with your CPA. If you realize you have years of R & D tax credits that you can claim, go back and pull the records of those expenses. You can amend 3 years of returns.
The R & D tax credits that we’ve discussed here were for federal tax purposes. Many states have their own version of R & D tax credits too.
If you do anything different, if you try things out, create new technology, new formulas or simply find a new system for your business, you have R & D tax credits coming your way. There is absolutely nothing to lose here.