If your business is investing in new or advanced products or processes, you might be eligible for a tax break from the federal government. This comes in the form of the research and development tax credit, also known as the credit for increasing research activities. It’s a way to get some of your investment back and reduce your tax bill.
So, how does it work? The basic credit is 20% of your research expenses for the current year, compared to what you spent in certain previous years. There’s also an alternative credit of 14%, which is a simpler way to calculate the credit.
What counts as research expenses? Well, there are two main types: in-house expenses and contract expenses. In-house expenses include wages for employees doing research and the cost of related supplies. Contract expenses cover 65% of what you pay to outside companies for research and testing.
You might be thinking that this credit is only for big companies developing new drugs or supercomputers. But that’s not the case. Even small changes can qualify for the credit. For instance, microbreweries and brewpubs could claim the credit for developing new beers or refining their brewing techniques.
To claim the credit, your research activities need to pass a four-part test. This includes proving that the research is basic and experimental, involves technological information, is useful for developing a new or improved part of your business, and involves some form of testing or experimentation.
If you think you might qualify for the credit, it’s crucial to keep detailed records of your activities and expenses. This includes payroll information, proof of expenses and supplies for R&D, contracts with outside companies, and documentation showing the process and expected impact of your research. No guesswork is allowed.
There are also special rules for small businesses. They can use the research credit to offset alternative minimum tax (AMT) or a portion of FICA. The definition of a "small business" varies for each of these options. For the AMT offset, a business with average annual gross receipts in the 3 prior years not exceeding $50 million qualifies. For the FICA tax offset, a small business means receipts under $5 million for the current year and no gross receipts for any year before the most recent 5-tax year period.
The credit is part of the general business credit, so it doesn’t amount to a separate credit but rather a limitation on claiming other credits. You can carry the general business credit in excess of what’s allowed in the current year back one year and forward for up to 20 years. So you don’t lose the credit and can save taxes in other years.
If you think you might be eligible for the research credit, it’s best to work with a tax professional. This isn’t something you should try to do on your own if you want to get the maximum credit amount and avoid any issues with the IRS.
