The global economy is in a state of turmoil and many businesses, particularly small businesses and startups, are desperately looking to their governments as the last resort for financial assistance to help them survive the recession and avoid bankruptcy. While many countries have financial relief programs in place, most of these programs are due to expire soon and only cover a short time frame.
However, each year the US government gives out billions of dollars in funding to businesses of all sizes through the R&D tax credit program to enable them to innovate faster, compete in the global market, and retain jobs.
While the R&D tax credit is an ongoing program that does not expire, the application process is cumbersome and time-consuming deterring many small businesses from applying.
Additionally, there is a common misconception that the R&D tax credit program only applies to companies with scientists performing research work in a lab, when in reality, the program was designed to support research and experimentation in all industries, from life science and manufacturing to software development, agriculture and beyond.
Through this brief guide you will learn everything you need to know about getting $250,000 from the R&D tax credit program without breaking your back.
How can I fund my business through the R&D tax credit program?
If you are a startup or small business that is paying $500,000 to developers to build new software or add features to existing software, you could potentially get $50,000 as a refund check from the IRS.
The math works out to approximately 10% of your qualified research and development costs that can be recovered through the Federal R&D tax credit. In addition to the Federal program, every State has its own R&D tax credit program as well.
There are two ways R&D tax credits can fund your business:
- You can use R&D tax credits to reduce your tax liability if your business is profitable and you owe corporate income taxes.
- If your business is not profitable, you can use R&D tax credits to offset up to $250,000 in social security payroll taxes and get a refund check from the IRS. To qualify for the social security payroll tax offset, you need to have gross receipts/revenues of less than $5 million for the tax year, and have gross receipts/revenues for five years or less from the tax year.
What is the R&D Tax Credit qualification criteria?
In order to qualify for the R&D tax credit, your research and development activities need to meet the 4-part test below:
- Develop new or improve existing functionality, performance, reliability, or quality of a product, process, technique, invention, formula, or computer software for the purpose of sale, lease, licence or use in your business.
- Eliminate uncertainty during the research and development process that you couldn’t resolve using publicly available information.
- Utilize a systematic process of experimentation to evaluate one or more alternatives in order to eliminate uncertainties and achieve the desired end result.
- Utilize principles of engineering, computer science, or physical or biological sciences.
In order to translate this to your business, you need to ask yourself if you have:
- Created a new product or software application, made improvements, or added new features to an existing product or software application.
- Integrated various databases or applications that were not designed to communicate.
- Improved response time of your software application.
- Created a new formulation or modified an existing one.
- Modified existing products or machines to perform new tasks.
- Developed new processes to scale up production of products.
- Developed packaging with improved shelf life, product quality and longevity.
- Incurred costs related to a process, project, or prototype that is incomplete because of unresolved technical problems.
What expenses can I claim for the R&D tax credit?
- Taxable wages for employees who perform or directly supervise or support qualified activities in the US.
- Contractor costs if you’ve outsourced some of your development activities. It is important to note that the contractors need to be working in the US and your company needs to retain the rights to the R&D and associated intellectual property resulting from their work.
- Hosting costs related to the R&D work, example, Google Cloud, Amazon Web Services, Microsoft Azure, etc.
- Cost of supplies used in qualified activities, including extraordinary utilities, excluding capital items or general administrative supplies such as travel, shipping, or royalty expenses. E.g. prototypes and testing materials.
What is the application deadline and when will I receive the money?
The R&D tax credit application needs to be filed with your annual corporate income tax return.
The filing deadline for S-corps with a December year end is March 15 and the filing deadline for C-corps with a December year end is April 15. You also have the option to request a 6-month extension to September 15 or October 15.
If your business is profitable, then your corporate income taxes will be reduced by your R&D tax credit amount.
If your business is not profitable, you can use R&D tax credits to offset up to $250,000 in social security payroll taxes and get a refund check from the IRS. You can start offsetting social security payroll taxes for the calendar quarter that begins after you file your income tax return along with the R&D tax credit form.
Businesses are required to pay 6.2% of each employee’s salary up to $137,700 as social security payroll tax. This is reported once a quarter on Form 941 – Q1’s social security taxes are reported in April, Q2’s social security taxes are reported in July, Q3’s social security taxes are reported in October, and Q4’s social security taxes are reported in January.
If you file your 2019 R&D tax credit claim along with your income tax return by October 15, 2020, you can offset social security taxes starting the first quarter of 2021 and receive your refund check by April 2021.
What is the application process?
Preparing the R&D tax credit application on your own can be a stressful process and a distraction from your business as you need to understand the IRS tax guidelines for the credit.
You then need to identify all the research and development activities undertaken by your company that would qualify per the eligibility criteria.
Then you need to identify employees that worked on those activities and prepare time estimates for them as well as compile their wages.
You also need to identify other research and development expenses such as contractors, hosting costs, and supplies, and have evidence to show that they were required for the R&D activities.
Lastly, you need to prepare the necessary supporting documents and tax forms, and file it with your corporate tax return by the deadline.
There is a lot of money at stake here and we recommend using an R&D Tax Credit Software like Boast.AI that also has a team of experts to take the burden off your shoulders. Boast makes R&D tax credit applications hassle-free by managing the entire process including identifying eligible projects and expenses, preparing the technical narrative and financial reports, compiling the tax forms, and supporting applications through audits. Boast only charges its fee once its customers receive their money from the government, thereby enabling businesses to get funding without the risk and effort.