Research and development (R&D) plays a pivotal role in the growth of any company, regardless of its size or industry. It is crucial for business innovation and ensures long-term sustainability in a dynamic market. But, there is more to research and development than maintaining a competitive edge, your business can also benefit from various tax credits to maximize its benefits. In this article, we explore research and development (R&D tax credits).
Overview of R&D tax credits
The Federal Research and Development tax credit, was initially introduced by the Economic Recovery Tax Act of 1981 (ERTA). This is designed to reward companies developing new or improved products, processes, or software in the United States. It does so by encouraging business improvement with incentives for research and development, reducing tax liabilities, and fostering capital investment. While this may be a powerful tax-saving tool, our CPAs have found that it is often underutilized. In most cases, this is because businesses either aren’t aware of the qualifying deductions in this regard or simply don’t understand how it works.
Understanding R&D tax credits
The R&D tax credit represents a dollar-for-dollar reduction in income tax liability. Various industries, including but not limited to Manufacturing & Distribution, Software & Technology, and Construction often incur R&D-qualified expenses. Food & Beverage, Consumer Products, Cannabis, and Healthcare can also easily accumulate these.
Eligible companies can significantly reduce federal tax liability, with the option to carry forward unused credits for 20 years. This means that if a company doesn’t use the full amount of its R&D tax credit in a given year, it can carry forward the remaining credits to offset future income tax. Additionally, as of the 2023 income tax return filing, qualified small businesses can use the R&D tax credit to reduce income taxes. They can also use it to offset a portion of the employer-paid Federal Insurance Contributions Act (FICA) and Medicare taxes. This provides additional financial relief and support for smaller enterprises. As such, R&D tax credits not only fuel innovation but act as catalysts for continuous improvement and technological advancement within various industries.
Federal R&D credit calculation
When it comes to calculating the Federal Research and Development credit, your business would need to sit with a CPA. This would help to determine which of the research expenses are considered qualified research expenditures (QREs) for the year compared to a base.
This base serves as a reference point for assessing the increase in research activities and can be calculated using two methods. These include the regular method and the alternative simplified credit (ASC) method.
- The regular credit method considers various factors. These include historical QREs, historical gross receipts, and the year a company began its operations. It aims to provide a comprehensive view of the company’s research efforts over time.
- The alternative simplified credit method, as the name suggests, offers a simpler calculation. It primarily relies on the QREs in the three immediately preceding tax years, streamlining the process for companies.
Understanding and carefully analyzing these calculations are crucial for optimizing the R&D tax credit. By accurately determining QREs, choosing the appropriate calculation method, and ensuring compliance with IRS guidelines, a company can maximize the benefits of the credit.
Recent legislative changes
The following legislative acts expanded the benefits of the R&D tax credit in the following ways:
- The Protecting Americans from Tax Hikes (PATH) Act in 2015 and the Inflation Reduction Act in 2022 expanded the scope of the Research and Development (R&D) tax credit. They introduced a new capability for the R&D tax credit to offset Social Security payroll taxes for qualified small businesses.
- The 2017 Tax Cuts and Jobs Act (TCJA) introduced the capitalization of R&D expenditures. This means that instead of deducting R&D expenses in the current tax year, companies are required to capitalize these expenses and amortize them over a period of time.
Recent IRS releases, including Chief Counsel Memorandum (CCM) 20214101F, Notice 2023-63, and proposed changes to Form 6765, provide additional guidance and updates. Companies should stay informed about these changes and consult with their CPAs for advice regarding potential legislative updates. It is crucial to carefully consider their eligibility for R&D tax credits and consult with their tax advisors to optimize their tax savings.
At Fusion, our CPAs have years of experience doing tax planning for large companies. This includes finding all of the appropriate R&D tax credits that could benefit the business. We have worked with companies from many different industries and understand the different strategies needed for the best tax planning. For personalized assistance and to explore how your company can benefit from these credits, contact us today!
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This blog article is not intended to be the rendering of legal, accounting, tax advice, or other professional services. We base articles on current or proposed tax rules at the time of writing and do not update older posts for tax rule changes. We expressly disclaim all liability regarding actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
