(Photo by Flickr user J R, used under a Creative Commons license)
The corporate tax deadline is five days away, and if you don’t know about the U.S. Research & Experimentation (R&D) Tax Credit program, you could be leaving $250,000 left on the table.
Each year the federal government provides billions of dollars to innovative businesses, including technology companies and startups, for developing new or improving existing technologies, products, materials and processes through the R&D Tax Credit. It’s classified as a general business tax credit under Internal Revenue Code section 41.
Ever wonder why Amazon pays very little, if anything, in federal corporate taxes? This is part of the reason why.
Even though the R&D tax credit system has been around since 1981, many small businesses are either not aware of it or shy away from applying because the process can be cumbersome and expensive. On the flip side, tech giants like Amazon and Apple can afford lawyers and accountants to process their R&D credits. Smaller businesses, which are the true engines of innovation and economic growth, often miss out on this crucial incentive.
But it doesn’t have to be this way. As someone who built a business helping companies apply for this credit and applied for it myself as a founder of two startups, let me break it down for you.
Why should I apply for the R&D tax credit?
Extra funding for R&D is a no-brainer. As a business developing new or improving existing technologies in the U.S., your startup could recover a portion of your expenditures to offset payroll taxes owing up to $250,000 per year which comes as an IRS refund, or to reduce income taxes owing. That’s a lot of cash to leave on the table, especially if you’ve had to pivot and adapt to the challenges of 2020.
How do I know if my business qualifies?
- Startups can apply the credits toward FICA payroll tax liability of $250,000 per year if they are either pre-revenue or they had less than $5 million in gross receipts for the tax year with no gross receipts for more than five years from the tax year. For example, if you are claiming R&D tax credits for the fiscal year 2020, you should not have gross receipts before 2016, and you should have less than $5 million in gross receipts in 2020.
- If your company doesn’t fall into those two categories, then you can carry forward the credit to 20 years (or back one year if you had profits).
What work qualifies for the R&D tax credit?
In simplest terms, work intended to achieve innovation within a scientific or technological field and passes the four-part test below is eligible:
- New or improved business component — The work must be done to develop a new or improved product or process.
- Technological uncertainty — The work must be done to resolve technological uncertainty. A technological uncertainty exists if publicly available information and knowledge cannot be applied to achieve the desired result.
- Systematic process — The work must be done systematically process to evaluate one or more alternatives to achieve the desired result.
- Technological — The work must be within the physical or biological sciences, engineering or computer science.
How do I know if the work I’m doing qualifies for R&D tax credits?
Ask yourself the following questions:
- Are you involved in engineering, design, data collection, testing or other developmental work?
- Have you designed or developed new software?
- Have you changed a process to reduce costs?
- Have you created a new product, made improvements or added new features to an existing product, or built a prototype?
- Have you incurred costs related to a process, project, or prototype that is incomplete because of unresolved technical problems?
If you’re still overwhelmed after reading this but are interested in getting credit for the R&D investments you’ve made in your business, this simple infographic may help.
While I do think every eligible company should apply for the R&D tax credit, I will say that the current system is flawed. In its current form, virtually everything about our R&D system is designed to favor big corporations and put federal incentives out of reach for smaller startups.
But don’t let this keep you from exploring the R&D Tax Credit as an option for your business. Investment in R&D is critical for your business and American innovation, and if you haven’t filed your corporate tax return yet, I encourage you to explore this now. There’s still time with five days left before the April 15 deadline or you can file for a six-month extension.
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