Glossary Finance Research and Development Tax Credit

Research and Development Tax Credit

What is R&D Tax Credit?

The Research and Development (R&D) Tax Credit is a tax incentive sponsored by the government to reward companies that conduct research and development in the United States. 

The R&D Tax Credit is not limited to large scale businesses or major corporations. If your business conducts activities relating to applied sciences, cutting edge technological innovations and other experimental projects, you can apply for the R&D Tax Credit. 

How to Qualify for the R&D Tax Credit?

The main objective of the R&D Tax Credit is to incentivize research activities. To qualify for this, there is a 4 part eligibility test established by the Internal Revenue Service (IRS).

Elimination of Uncertainty

The first part of the eligibility test is where you demonstrate how you have attempted to eliminate uncertainty about the development of a product. 

Process of Experimentation

The second part is where a complete demonstration is carried out through methods such as simulation, modeling, systematic trial and error, etc. This will show that you have evaluated other alternatives before achieving the results shown.

Technological in Nature

The third part is concerned with the process of experimentation through hard sciences such as computer science, engineering, biology, physics or chemistry.

Qualified Purpose

The fourth part is also referred to as the Business Component Test. Here, the purpose of research should be declared and what problem it aims to resolve when it comes to creating and improving a new process or product. The results achieved should also be stated such as an increase in performance, reliability and function, etc.

What are the Benefits of Claiming the R&D Tax Credit?

There are many benefits of claiming the R&D Tax Credit, the 2 main ones are listed below.  

Social Security

When you avail the R&D Tax Credit, this will cancel out the social security tax so that small to medium scale businesses can derive a benefit from their research and development activities.

Alternative Minimum Tax

The Alternative Minimum Tax (AMT) was implemented to ensure that taxpayers pay at least the minimum tax amount. AMT recalculates the income tax and adds particular tax preference items into the adjusted gross income. With the R&D Tax Credit, you can get a tax cut on AMT if you meet the eligibility requirements.

How to Claim the R&D Tax Credit?

When claiming the R&D Tax Credit, the taxpayer should document all research activities in order to show the amount of research expenses paid for each research activity. When it comes to this, some research expenses will be estimated which is allowed as long as there is a factual basis for these assumptions.

The following documents will be required to claim the R&D Tax Credit. 

  1. General ledger expense details.
  2. Project research and development notes.
  3. Project research and development lists.
  4. Payroll records.

These documents will be combined with credible employee testimonies. This way, your claim will be substantiated much faster and will ensure that you receive the full entitlement of the R&D Tax Credit under the IRS and Treasury regulations.