What is the R&D tax credit?

Also known as the research and experimentation tax credit, the research and development (R&D) tax credit under section 41 of the Internal Revenue Code (IRC) is a general business tax credit that helps U.S. businesses significantly reduce their tax liability.

Businesses that incur expenses for conducting research and development activities in the U.S. may be eligible to apply for the R&D tax credit if they meet the qualifying criteria stipulated in section 41 of the IRC. Eligible small businesses can also use up to $250,000.00 of their R&D tax credit to offset payroll taxes.

Qualifying expenses:

Qualifying expenses include the wages paid to employees who performed qualifying services, supplies used for conducting research, contract research expenses, certain amounts paid to energy consortia, research payments to qualified organizations, and the cost of renting or leasing computers used to perform qualified research activities.

Qualifying R&D activities:

Research that is technological in nature.

The testing of a product or process must rely on principles of the natural sciences.

Research that attempts to discover new information or resolve an uncertainty.

The information and insight gained from the research should be useful to the development or improvement of a product or process.

Research that involves testing or experimenting.

Activities must be part of a process of experimentation, such as modeling, trial and error, or simulations, to achieve results.

Research that has a qualifying purpose.

The purpose of the research must relate to a new or improved function, performance, reliability or quality.

How to claim the R&D tax credit:

Assess whether any of your business's projects, products, and processes qualify. Examine whether any activities meet the qualifying criteria of being technological in nature, involve experimentation, constitute an attempt to eliminate uncertainty, and are being performed for a qualifying purpose, such as quality improvement.

Identify and track qualifying expenses. Make sure that all qualifying expenses, such as the wages paid to employees who performed qualifying services, supplies used for conducting research, and contract research expenses, are documented separately.

Collect supporting documentation. Besides financial, tax, and payroll records, you should also gather any documentation that can show the connection between the expenses and activities, as well as demonstrate the nature of the activities. Such documentation might include time-tracking records, project development notes, testing reports, email communication, patents, and more.

Submit your R&D tax credit application with your tax return. Complete Form 6765 "Credit for Increasing Research Activities". If you want to use some of your R&D tax credit to offset payroll, you must elect payroll tax credit in section D of the form. The completed form must be attached to your tax return. See detailed instructions for Form 6765 here.

If you elected the payroll tax credit on Form 6765, you must also complete and submit Form 8974 "Qualified Small Payroll Tax for Increasing Research Activities". Once completed, Form 8974 must also be attached to your tax return. Find detailed instructions for Form 8974 here.