This research and development (R&D) credit applies to many small businesses and not just large labs or pharma companies. If your small business has software development, manufacturers, or processes chemicals or foods, then research and development is probably occurring. Stage 1 Financial can help you identify if this credit is right for your business, and then we can help you get it. If you are interested in seeing how it would apply to your business, fill out this survey.
The basic credit is 20% of research expenses for the current year over a base amount reflecting such costs in certain prior years. There is also an alternative credit of 14%, which is a simplified way to figure the credit.
Research expenses for purposes of the credit include:
- In-house expenses. These include wages paid to employees for doing research and its related supplies.
- Contract expenses. These are limited to 65% of amounts paid to outsiders for research and testing.
To claim the credit, your research activities must meet a 4-part test:
- Basic research test (the expenditure is incurred in your business and represents R&D in the experimental or laboratory sense).
- Technological information test (discovering information that is technological in nature).
- Business component test (the application is intended to be useful in the development of a new or improved business component of your business).
- Process of experimentation test (testing surveys, modeling, simulating, etc.)
Take the first step to finding out if your company meets the requirements for this tax credit by filling out our survey. We will follow up with you and outline the next steps.
There are two ways your small business can use the research credit:
- Offset alternative minimum tax (AMT).
- Offset a portion of FICA.
There are two definitions of what a “small business” is depending on which type of credit you want to use.
AMT offset. Sole proprietors, partners, and S corporation shareholders can offset their personal AMT by their share of the research credit. This option applies to a business with average annual gross receipts in the three prior years not exceeding $50 million. For partners and S corporation shareholders, the test must be met at both the entity and owner levels.
FICA tax offset. At the business’s election, the research credit can be used to offset up to $250,000 of the employer’s share of Social Security taxes (a portion of FICA) paid on wages of employees. A small business for this purpose means receipts under $5 million for the current year and no gross receipts for any year before the most recent five tax year period ending with the current year (current year plus four prior years).
MORE DETAILS ON WHAT IS QUALIFIED RESEARCH
Taxpayers can claim an R&D credit for basic research payments made in the tax year under IRC section 41(a)(2). Basic research is defined as an original investigation to gain scientific knowledge without having a specific commercial objective. This definition does not include basic research conducted outside the United States, nor research in the arts, humanities, or social sciences. Basic research must be performed by a qualified organization, which includes certain qualified educational systems considered to be higher educational institutions, qualified scientific research organizations, and qualified grant organizations under IRC section 41(a)(2).
Treasury Regulations section 1.41-4(a)(4) provides that the research must be technological in nature and discover new information (the discovery test). Developing software products that are new and innovative compared with other commercially available software products in the field does not mean discovery of new information, nor does the mere evidence that the taxpayer has developed a new and useful product in and of itself qualify as discovering new information [Tax and Accounting Software Corp. v. U.S. (2002, CA10) 90 AFTR 2d 2002-6107].
Under Treasury Regulations section 1.41-4(a)(5), a process of experimentation is one designed to evaluate one or more alternatives to achieve a result that is uncertain at the beginning of the research activities. Evaluating alternatives can involve modeling, simulation, or a systematic trial and error methodology; this means that simple trial and error to evaluate alternatives in order to validate a process is not sufficient [Union Carbide Corp. and Subsidiaries v. Comm’r; (2009) TC Memo 2009-50]. In addition, evaluating alternatives to eliminate uncertainty arising during the project does not meet the process of experimentation requirement since the uncertainty was not at the beginning of the research activity (U.S. v. Davenport, 110 AFTR 2d. 2009-2722).
EXAMPLES OF APPLICATION
- USE OF CHEMICAL TECHNOLOGY
- PROTOTYPES AND NEW PRODUCT SAMPLES
- NEW OR IMPROVED MANUFACTURING OR PRODUCTION PROCESSES
- E-COMMERCE SOFTWARE DESIGN
COULD THIS R&D CREDIT BE RIGHT FOR YOU?
We want to help as many businesses as we can to take advantage of credit programs like this. You work hard to build your business, and we are here to support you and make your vision a reality. If you think this tax credit is a viable option for your business, get in touch with our tax experts today at firstname.lastname@example.org. We can quickly identify if it’s the right choice for you and get things rolling.