There’s a common misconception that the IRS research and development (R&D) tax credit is only available to researchers and scientists. In reality, this tax credit offers a great opportunity for small businesses to reduce their tax liability. CO— spoke to Dave Tilstone, strategic advisory board member at alliantgroup and Senior Business Development Officer at ATHENA, to learn more about the R&D tax credit and how you may be able to apply it to your 2022 tax return.
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What is the R&D tax credit?
The research and development tax credit was originally established in 1981 to incentivize innovative R&D across the United States. The 2015 Protecting Americans from Tax Hikes (PATH) Act made the R&D tax credit permanent, modified the benefit for small businesses, and made the credit available to startups. While the phrase “research and development” might call to mind white lab coats and ground-breaking discoveries, this credit can apply to a broad range of business activities.
“The truth is that qualifying for the credit is not complex,” said Tilstone. “Your company simply needs to be working to improve a product or process here in the U.S. There are a number of qualifying research activities (QRAs) that apply to thousands of businesses, including small and mid-sized, in countless industries.”
Unfortunately, Tilstone says, less than 3 in 10 businesses who qualify for the credit actually claim it, while virtually every large company makes the claim. Quite often small businesses leave significant amounts of money on the table because of common misconceptions about this particular credit.
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It’s worthwhile to take the time to discern what parts of your business operations could apply toward this credit. “You get 13 cents back on every dollar spent on qualified research,” said Jim Breese, CMO at Green Growth CPAs. States also offer R&D tax credits at varying rates. To estimate how much you could claim toward this credit, try alliantgroup’s R&D tax calculator.
More often than not we find that new clients have been under-claiming the credit, if they have taken it at all.
Dave Tilstone, strategic advisory board member, alliantgroupm and Senior Business Development Officer, ATHENA
What activities qualify for the R&D tax credit?
There are two broad categories of activities that a business can claim towards the R&D tax credit: qualified research activities (QRAs) — sometimes called qualified research expenses (QREs) — and basic research payments (BRPs). Most small businesses can claim expenses under the QRE category.
“For example, architecture firms can qualify for the credit by designing master plans or building systems, an everyday occurrence in the field,” said Tilstone. “Those in the software and tech industry can qualify by designing and implementing cloud-based IT solutions. Manufacturers can qualify for the credit when they develop second-generation products. The possibilities are endless, which makes the credit so flexible and valuable.”
Here are some other examples of activities that can go toward this credit:
- Developing or designing new products.
- Making enhancements to existing products or processes.
- Developing or improving upon existing prototypes and software.
Speak to a tax professional to see if any aspect of your business operations can go toward the R&D credit.
How to claim the R&D tax credit
The IRS requires documentation to be submitted to back up your R&D tax credit claim. Experts recommend that you rigorously document any activities you wish to claim toward research to establish how much was spent on qualified research activities. The burden of proof lies with the taxpayer; so, as a result, keep documents such as:
- Payroll records for employees involved in R&D.
- Expenses, receipts and accounts for supplies and equipment related to R&D.
- Contracts and invoices paid to any third-party partners involved in R&D.
- Blueprints, patents, designs, drawings and prototypes related to research.
- Project and meeting notes related to research.
Tilstone strongly recommends partnering with a CPA or accountant to make sure you’re eligible for this credit. “More often than not we find that new clients have been under-claiming the credit, if they have taken it at all,” he said. “We have found that during this difficult period, small and mid-sized businesses have been able to use the capital from the credit as a lifeline to keep their doors open and pay their employees. It’s likely that your peers are using it in an attempt to get through this difficult time. The capital that businesses can bring in because of the credit can go toward any growth effort: hiring new employees, investing in new infrastructure, integrating new technologies to increase competition.”
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