O ne of the options some businesses have to minimize their tax bills is the research and development or R&D tax credit. The credit allows businesses to take business expenses related to research and development off their tax bills. Businesses can only claim the R&D credit for specific, tech-related expenses.
Below, we explore what the R&D credit is, what it applies to, and how you request it. Then, we discuss the impact of different business structures on the credit.
What Is the R&D Tax Credit?
The Internal Revenue Service (IRS) calls the research and development tax credit (also known as the research tax credit) the “credit for increasing research activities.” Businesses can claim the credit for qualified research expenses. You can calculate the credit amount in one of two ways: the regular research credit calculation (RRC) and the alternative simplified credit (ASC).
R&D Expenses
To claim the R&D credit, you must have incurred valid R&D expenses. You incur those expenses by completing qualifying research activities (QRAs). Whether an activity qualifies depends on whether it involves:
A qualified purpose—the activity is intended to develop or improve upon a product or process
Technological uncertainty—the best way to achieve that purpose is uncertain
An experimentation process—to address the uncertainty, the activity involves a scientific experimentation process
Application of scientific principles—the activity is technological and related to hard sciences
Hard sciences that may qualify as technological include but are not limited to:
Physics
Chemistry
Biology
Computer sciences
Even if you use scientific methods, research related to social sciences typically does not qualify.
You may generally claim the credit for QRA expenses related to:
Employee compensation
Supplies
Third-party research contracts
Renting computer storage space
To qualify for the credit, these expenses must be directly related to the QRA.
R&D Credit Calculation Using IRS Form 6765
Calculating your R&D credit begins with either the regular research credit calculation (RRC) or the alternative simplified credit (ASC). You can use IRS Form 6765 to complete both calculations and determine which saves you more.
Under the RRC, you can claim a credit for approximately 20% of your QRA expenses that exceed a specific amount. That amount depends on your business’s past earnings, history, and size. Under the ASC, you begin the calculation by totaling the current year’s qualifying expenses. Then, you average the qualifying expenses from the past three years. Next, divide the three-year average calculation in half, then subtract that number from the current year’s qualifying expenses. You can typically claim approximately 14% of that subtracted amount.
R&D Qualified Small Businesses
If they meet the other requirements, businesses of any size may claim the R&D tax credit. However, small businesses have extra options. If you have a qualified small business (QSB), you can elect to take a payroll R&D tax credit. This extra credit allows you to apply no more than $500,000 against employment taxes related to social security.
Your business may be a QSB if you have gross receipts of less than $5 million for the tax year when you apply and no gross receipts from more than five years ago. In this context, gross receipts include all amounts the business received during the year without subtracting expenses.
R&D Eligible Small Businesses
Eligible Small Businesses (ESBs) can also use the credit against the alternative minimum tax (AMT). ESBs can be:
Sole proprietorships
Partnerships
Corporations without publicly traded stock
To qualify as an ESB, your annual gross receipts from the past three years must average $50 million or less.
R&D Tax Credit Examples
The following R&D tax credit examples demonstrate how the credit works in the real world:
Software development—you can deduct costs related to designing, testing, and implementing new software to protect private data.
Healthcare—you can deduct expenses related to designing, developing, and manufacturing new medical equipment.
Technology—you can deduct costs associated with researching how to make existing technology more environmentally friendly.
Many other situations may qualify for the credit as well.
Claiming the R&D tax credit may be a no-brainer for eligible businesses but requires careful documentation and filing.
Business Structures and the R&D Tax Credit
Your business’s structure does not necessarily affect your ability to claim the credit. However, the application process and some practical considerations can vary depending on your business structure.
R&D Tax Credit for a C Corp
Generally, C corporations claim the R&D credit using IRS Form 3800, the form for claiming general business credits. Typically, C corporations are less likely to qualify as QSBs or ESBs or be able to claim the extra credit or offset against the AMT.
R&D Tax Credit for an S Corp
To claim the R&D tax credit for an S corp, you must complete Form 6765. Then, you transfer the information from Form 6765 to Form 3800. Finally, you file the two forms together with your Form 1120-S.
R&D Tax Credit for a Partnership
Like S corporations, partnerships must claim the R&D tax credit using Form 6765. Also, like S corporations, once you complete Form 6765, you should complete Form 3800 and file them together with your Form 1065.
R&D Tax Credit for an LLC
How you claim the R&D tax credit for an LLC depends on how you elected to have the LLC treated for federal tax purposes. Follow the rules for the LLC’s tax treatment. If you treat your LLC as an S corporation or partnership, use Forms 6765 and 3800. If you treat it another way, you typically only need to file Form 3800.
R&D Tax Credit for a Sole Proprietorship
Typically, you can use both Forms 6765 and 3800 for a sole proprietorship or just Form 3800. Because sole proprietorships tend to be small businesses, they are more likely to qualify as an ESB or QSB.
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Applying for R&D Tax Credits
Estimates suggest that, through the R&D tax credit, you can get back somewhere between one and 10 cents for every dollar you spend on research and development. This credit can add up quickly, resulting in a lowered tax bill or, for some small businesses, an offset against employment taxes. For businesses that qualify, claiming the credit may be a no-brainer, but ensure you file the correct documents based on your business’s structure.
Frequently Asked Questions (FAQs)
What Are R&D Tax Credits?
R&D tax credits are credits for research and development. When you claim a tax credit, you apply it after calculating your tax bill for the year.
What Qualifies for an R&D Tax Credit?
You can claim the R&D credit for qualifying research activities (QRAs). QRAs must:
Be intended to improve or develop a product or process (qualifying purpose)
Involve uncertain means to achieve that purpose (technological uncertainty)
Involve a scientific experimentation process (experimentation)
Relate to hard sciences (technological activity)
The activity must fit all four of these requirements to qualify.
When Can I Claim R&D Tax Credits?
You can claim R&D tax credits as part of your annual tax return process. Generally, you can claim credits for expenses above an amount that depends on your business history. If you qualify as an ESB or QSB, you may claim an extra payroll tax deduction and potentially offset the AMT.
How Much Is the R&D Tax Credit Worth?
The R&D tax credit amount varies from business to business. However, it may add up to a recovery of between 1% and 10% of your qualified expenses.
Disclaimer: Bizee and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
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Key Takeaways
- The R&D tax credit allows businesses to deduct specific research and development expenses to reduce their tax bills.
- Qualifying research activities (QRAs) must have a qualified purpose, involve technological uncertainty, and follow a scientific experimentation process.
- Expenses eligible for the R&D credit include employee compensation, supplies, third-party research contracts, and rented computer storage.
- Businesses can calculate the R&D credit using the regular research credit calculation (RRC) or the alternative simplified credit (ASC) via IRS Form 6765.
- Qualified Small Businesses (QSBs) can apply up to $500,000 of their R&D credit against payroll taxes if they meet gross receipt requirements.
- Eligible Small Businesses (ESBs) with average gross receipts under $50 million can offset the Alternative Minimum Tax (AMT) using the R&D credit.
- Examples of R&D tax credit applications include developing new software, medical equipment, or environmentally friendly technologies.
- Business structure impacts the application process for the R&D credit, with different forms required for C corps, S corps, partnerships, and LLCs.
- Sole proprietorships can claim the R&D credit using Forms 6765 and 3800 and are often eligible as QSBs or ESBs.
- C corporations are less likely to qualify as QSBs or ESBs but must use Form 3800 for claiming general business credits.
- R&D tax credits can provide 1% to 10% returns on qualified expenses, significantly lowering tax liabilities for eligible businesses.
- Accurate filing based on the business structure is essential to maximize the benefits of the R&D tax credit.
