How Can Tech Companies Maximize the R&D Credit?

The research and development (R&D) tax credit has been around since the 1980s, but in recent years, it has seen a resurgence. The Protecting Americans from Tax Hikes Act (PATH Act) of 2015 made the credit permanent, and the Tax Cuts and Jobs Act (TCJA) of 2017 made changes to the tax code that allow more taxpayers to take advantage. In the last few years, technology companies of all sizes have written it into their tax plans and will continue to do so well into the future. If you haven’t already considered the R&D tax credit, now is the time to see if you can claim the benefits it provides. To help clients, prospects and others understand the opportunity, Wilson Lewis has provided a summary of key details below.

Credit Basics

The R&D tax credit, officially known as the Research & Experimentation Tax Credit, incentivizes businesses to develop new (or improve existing) products, technologies, and processes. The credit is calculated on Form 6765 and then reported on Form 3800 alongside other general business credits, ultimately flowing to the individual taxpayer’s or corporation’s tax return. There are multiple ways to calculate the credit, but generally, up to 9.1% of a taxpayer’s R&D expenditures can be used to offset their Federal tax liability.

Eligibility

To receive the incentive, entities must perform research and development on what the IRS calls “qualifying research activities” (QRAs). QRAs are determined using a four-part test:

1. The activity must be technological in nature. It must rely on hard sciences like engineering, physics, biology, computer, or physical.
2. The activity must relate to a new or improved business component. The organization must be working toward a new or improved product, service, software, technique, process, formula, or invention that would be used or sold in their business.
3. The activity must require experimentation. There must be a period of testing, evaluation, and recalibration during the development process.
4. The activity must resolve technical uncertainty. In other words, to create or improve a business activity or design component, there must be a technological problem to solve.

For technology companies, R&D efforts that qualify as QRAs are activities like: designing new software programs; testing and evaluating existing programs; creating databases or document management systems; programming new source code; and building new electronic interfaces. Typically, the credit is intended to reward companies that develop technology and software for widespread use, but it is also available to those that develop internal software, as long as the software is (1) innovative; (2) developed under significant economic risk; and (3) not commercially available.

Qualifying Expenses

Almost all R&D expenses will count toward the credit, including the following:

• Wages paid to employees working on the R&D activity;
• Supplies used during the R&D process;
• Property purchased to be used in the activity;
• Contracted labor to work on the R&D activity on behalf of the taxpayer; or,
• Research payments made to educational or research institutions.

Typically, as long as an expense was incurred while performing a QRA, it will qualify for the credit.

Opportunities for Technology Companies

The R&D tax credit can be a great opportunity for those in tech. Many, if not all, of a technology company’s daily activities, will be classified as QRAs. Research and development does not have to be revolutionary or groundbreaking; it can be any project that is experimental and that looks to improve a process or create something new. To see if your activities qualify, review your daily activities using the four-prong test from above.

If your entity’s size or tax position disqualified you from the credit in the past, take another look; the regulations have changed. Eligible small businesses can now offset their Alternative Minimum Tax (AMT) with the R&D credit, and the AMT for C corporations have been repealed altogether. Without these AMT limitations, the credit is available to more taxpayers than ever before. Even some taxpayers in a loss position can take advantage; small startups can use the credit to offset their payroll tax liabilities.

Contact Us

The R&D tax credit can be a lifeline for technology companies that expend a significant amount of resources on research and development. There is potential to save hundreds of thousands of dollars in taxes, and for some companies, the credit is even refundable. If you have questions about claiming the R&D tax credit or need assistance with a tax or accounting issue, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.