INNOVATION HELPS to power New Hampshire’s economy. Talented people in firms small and large are building, testing, developing and researching. With the host of problems presented in 2020, some have set out to solve them in 2021. Many don’t know tax credits available for research and development.
What is the R&D tax credit?The research and development credit is a government-sponsored tax incentive offered to companies who create or improve a product or process in the course of their business.
On the federal level, there are two versions of the credit that eligible companies can claim: the traditional R&D credit and the payroll credit.
R&D credit
The R&D tax credit has existed since the early 1980s, and any company that is doing R&D, regardless of age, size and industry, is eligible to claim. It allows companies to recapture a percentage of their R&D investment to reduce income tax liability not only for their current tax year, but also retroactively for the past three. A retroactive credit will generate a refund or can be carried forward up to 20 years for future use.
As a permanent federal incentive, the R&D credit can be built into your company’s yearly financial plans and claimed every year the company is conducting eligible R&D. Additionally, many states, including New Hampshire, offer some form of the R&D credit that can be claimed in combination with the federal credit.
Payroll credit
With recent legislation changes, a second form of the credit was created to allow eligible startups to reduce payroll tax liability. Startups can claim this version for a maximum of five years and up to $250,000 each year. To be considered a startup, your company’s gross receipts must be below $5 million each year, and you have to be within a five-year window since gross receipts were first incurred.
Who qualifies?
A common misconception is that research and development only takes place in laboratories with scientists in lab coats, or in designated research and development departments. The result is countless organizations across a wide range of industries miss out on claiming the credit each year because they don’t realize that their day-to-day operations qualify as research and development.
The best way to determine which activities will qualify for R&D tax credits in any industry is to use the IRS’ four-part test.
Business component test
Have you demonstrated that the information being discovered was to develop a new or improved product or process?
Technology test
Can you demonstrate your development relied upon the principles of the physical or biological sciences, engineering, or computer science?
Experimentation test
Have you demonstrated you went through a process of elimination, trial and error, or other evaluation of alternatives?
Uncertainty test
Have you demonstrated that you tried to learn something new about the product or process in order to improve it? Can you demonstrate the product or process could not be improved without going through this discovery process?
Qualified R&D expenses
Once the qualifying R&D projects are identified, there are four main cost categories tied back to the R&D activities that contribute to your credit potential:
W2 employee salaries.
Subcontracting costs.
Infrastructure expenses.
Raw materials.
You will receive 7 to 10% of your total R&D investment back as your R&D credit and/or payroll credit. Both versions of the credit are dollar-for-dollar incentives so a dollar of credit will directly reduce a dollar of tax liability.
Ross Barbee is a senior research and development tax credit consultant with Leyton – a global innovation funding consultancy with expertise in federal and state R&D tax credits. Contact Ross at [email protected] or direct at 860-0377.