The research and development (R&D) credit is a tax credit on your income tax return, not a deduction. That means, dollar for dollar, you can reduce your tax liability, in addition to deducting eligible R&D expenses.
R&D tax credit: How do you qualify?
We’ll work with your team to understand the activities and projects performed during the tax year to see if they meet the requirements for the R&D credit, which is based on four criteria:
- The purpose of the activity must be to discover information useful in the development of a new or improved product, process, software, formula, invention, or technique to improve the function, performance, reliability, and quality of a product or process.
- There has to be some technical uncertainty — is it even possible to develop and improve this product or process?
- Experimentation is required. Because of the uncertainty, testing or analysis must be done to evaluate alternatives. Examples of testing or analysis are physical testing, prototyping, modeling, and simulation.
- The activity needs to be technological in nature and based in science: biology, chemistry, computer science, and engineering all qualify.
What are the eligible expenses for the R&D tax credit?
Once we’ve determined that you’ve met the criteria, we’ll begin assessing the eligible expenses associated with the activity, which are:
- Wages for any employee performing R&D activities, as well as those directly supporting or supervising the R&D activities.
- Supplies used in the process of experimentation, such as prototypes or raw materials.
- Computer rental or lease costs, most commonly those for cloud computing services used for development and testing environments.
- Expenses associated with any outside service used during the research process from contract engineers, consultants, developers, outside lab testing, or the like.
After adding up the qualified expenses, there are two ways to compute a credit. The most common way is that we compare your R&D spend for the current tax year to the average spent over the last three tax years. As long as more than half of the three-year average is spent, you can expect to receive an R&D tax credit.
What activities don’t qualify for the R&D tax credit?
There are some exceptions as to what qualifies for the credit — the following activities wouldn’t qualify:
- Any research or activities conducted outside the United States.
- Any activities that could be considered routine maintenance or quality control.
- Surveys or polls.
- Reverse engineering or a duplication of an existing process or product.
- Social science or economic research.
How we can help
We can help you get the most out of your R&D tax dollars. The R&D tax credit is closely monitored by the IRS during the audit process, and new filing requirements mean documentation needs to be in place when the tax return is filed. Developing an annual process that can be used to effectively gather documentation such as notes, test results, time tracking data, cost data, and evidence of technological uncertainty or scientific experimentation will be key to substantiating and keeping the credits you earned.
Contact our authors
Do you think your business may qualify? Ensure you’re maximizing your R&D tax credit. Reach out to our team to get started.
