R&D Tax Credit Guide & How to Claim Research Expenses

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Learn how to maximize your research and development tax credit by deducting qualified research activities on your federal income tax return. Found under Section 41 of the Internal Revenue Code, the RDTC can reduce your income and payroll tax liability. You can apply via IRS Form 6765 (Credit for Increasing Research Activities).

What is the RDTC?

As denoted in U.S. Code, Title 26, Subpart D, § 41, the Research and Development Tax Credit (RDTC) is a dollar-for-dollar offset of federal income tax liability. It was enacted over 40 years ago in 1981, with the sole purpose of encouraging and supporting R&D progress across the nation.

By simply performing normal day-to-day activities, businesses in any industry such as computer science can utilize this employer tax incentive program for:

Developing, designing, or improving different types of products, processes, formulas, or software.

Any company with less than $5 million in annual average gross receipts and an improved business component can apply, including those subject to the Alternative Minimum Tax (AMT).

How it Works

Every year, roughly 6-8% of your qualified research expenditures can be applied against a company’s tax liability, in a dollar-for-dollar exchange at a federal level while state rebate levels can vary.

Eligibility

After the senate passed the Protecting Americans from Tax Hikes Act (PATH) in 2015, the RDTC was amended to expand eligibility for small business owners.

To be eligible for research and development tax credits, organizations must have less than $5 million in gross receipts in their current filing year.

How Much

R&D tax credits are available at both the state and federal government levels. When combined, business owners can claim an average potential benefit of 10-20% of their qualified research expenses.

In some cases, the RDTC can be also used to offset payroll tax liability up to a maximum of $250,000 annually, and up to a 5-year total of $1.25 million.

In the last year alone, an estimated total of $18 billing in research and development credits were approved for businesses in almost every industry.

Qualified Research Expenses

Companies of any size that actively engage in the research and development of new or improved products, inventions, techniques, formulas, or processes can apply for this tax credit.

Qualified spending can also go beyond product development to include research activities such as new manufacturing methods, product quality improvements, and software development.

Payroll Tax Credit

Like the Recovery Startup Business credit is part of the ERTC, the Research and Development Tax Credit has a similar provision related to the Federal Insurance Contributions Act (FICA).

Section D of IRS Form 6765 is required qualified startup businesses (QSBs) who take advantage of the RDTC to offset payroll taxes during their first five years of tax reporting.

Based on payroll records, startup businesses can claim an R&D payroll tax credit of up to $250k annually for their 5 years up to a maximum of $1.25 million. To be eligible, a business must have no more than 5 years of generating gross receipts, including the current tax year.

How to Claim

Business owners can claim an R&D credit by filing IRS Form 6765, which is labeled Credit for Increasing Research Activities. The application process requires you to identify your qualified research activities and to prove that your business expenses meet R&D requirements under Internal Revenue Code Section 41.

Documentation

The filing process for this business tax credit is likely to include financial records, business records, and oral testimony, along with details of the technological advances your research or development covers.

The documentation you file should also demonstrate that you continually evaluated all facets of your business research activities including itemized expenses incurred.

Oral Testimony

Beyond thoroughly documenting all of your yearly qualified expenses and research activities you should back up your claim with employee testimony. Adding a human element can help substantiate your RDTC claim, and ensure you receive the maximum you are entitled to.

Previous Years

To maximize your RTDC claim amount, be sure to provide comprehensive documentation for every year of eligibility including the current and previous tax years.

Form 6765

There are four sections found in Form 6765, where businesses can document all of their qualified R&D expenses. Section A is used to apply for the regular RTDC, while sections B, C, and D are related to alternative simplified credit claims, business structure, and payroll taxes.

When filling out Section A (regular) or B (simplified), the IRS recommends choosing the section which you calculate to have the greatest tax benefit.

  • Section A: For regular RDTC claims where lines 1,2,3,7,8,10,11 and17 must be filled out
  • Section B: Only required if applying for the Alternative Simplified Credit (ASC)
  • Section C: Identifies additional forms and schedules that warrant reporting based on business structure
  • Section D: Only required if applying to offset pay tax liability, as a qualified small business (QSB).