2020 Year-End Tax Guide

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Research and Development (R&D) Tax Credit: Applicability and Benefits

Thousands of companies from diverse industries benefit from the research and development (R&D) tax credit. The credit, which has been in existence since 1981, provides more than $10 billion of tax savings to U.S. businesses annually. The R&D tax credit, which is a dollar-for-dollar benefit, provides significant cash flow to taxpayers with qualifying expenses. This important benefit was made permanent by the 2015 Protecting Americans from Tax Hikes (PATH) Act. Recent changes to the PATH Act, as well as the Tax Cuts and Jobs Act (TCJA) have made the R&D tax credit even more lucrative. CALCULATING THE R&D TAX CREDIT The R&D tax credit is calculated by determining the amount of Qualified Research Expenditures (QREs) for a company’s current and prior tax years. QREs include wages, consumable supplies used in the R&D development, and 65% of third party contractor researchers’ expenses. In order to meet the definition of qualifying research expenditures, research activities are required to be performed in the United States and to satisfy a “four-part test”: 1. The work is performed to develop a new or improved business component (product, process, technique, formula, invention, or computer software component). 2. The activities are performed to discover information that is technological in nature. The activities involve physical, biological, engineering, or computer sciences. 3. The research is performed to eliminate technical uncertainty, determine if a desired result can be achieved, determine how to achieve it, or determine the specific design of a product.

4. The activities include a process of experimentation involving identification of the technical uncertainties, alternatives to consider in eliminating the uncertainties, and a process for evaluating alternatives. The R&D tax credit is not only available at the federal level, but 36 states also offer similar programs to incentivize business growth in such industries as:

Manufacturing & Distribution

X

Construction

X

Technology & Life Science

X

Food & Beverage

X

Alternative Investment Group

X

Healthcare Cannabis

X

X

PAYROLL TAX RELIEF The PATH Act not only made the R&D tax credit permanent, it enacted a key incentive which allows qualified small businesses to offset the 6.2% employer’s Social Security portion of payroll taxes. The payroll relief is not limited to R&D employees, but rather, can be used to offset the employer’s share for all employees. A qualified small business is generally defined as a business operating for less than five years and has less than $5 million of annual gross receipts. The R&D payroll tax credit can offset up to $250,000 of payroll taxes per year for up to five years. The credit may also be claimed if the business uses a certified Professional Employer Organization (PEO). This provision gives more qualified small businesses the ability to utilize the R&D tax credit, where the lack of taxable income might have prevented them from using this benefit previously. As indicated by its name, the R&D credit offsets a company’s taxes. Since many small, start-up businesses operate at a loss in their early years and are cash strapped, the payroll offset related to the R&D tax credit now provides some relief to this scenario.