How Does The R&D Tax Credit Work?

3 Minute Read
Posted by Randy Eickhoff on Aug 5, 2020 8:47:25 PM

The research and development (R&D) tax credit first launched in the early 1980s due to our economic slowdown and decrease in R&D spending. Moreover, U.S. technical jobs were going offshore. This incentive would help reverse this trend by lessening the burden on riskier R&D initiatives, thus encouraging U.S. investment as a means to both stimulate economic growth as well as help the U.S. keep pace with other world innovation leaders.

Because the R&D tax credit was income based, many startups and pre-revenue organizations were unable to utilize the credits simply because they didn’t pay tax. Additionally, initial legislation also had strict guidelines that the R&D had to be groundbreaking, making it exceptionally challenging for smaller companies with limited budgets to move their R&D projects forward.

The Research and Development Tax Credit Has Evolved Significantly Over the Years

Fortunately, the R&D tax credit has undergone extensive iterations in almost four decades. In 2004, the IRS published final regulations loosening the rules for qualification. Your research and development efforts didn't need to expand the knowledge of your industry, but rather only had to be “new to the taxpayer.” Expanding the qualification definition instantly made the benefit more accessible to a larger number of organizations.

This exclusion of smaller organizations further changed in 2015. That’s the year the U.S. federal government opened the door with new legislation for early-stage companies to leverage the credit incentive for as much as $1.25 million (or $250,000 every year up to five years) to offset a portion of their yearly payroll taxes. Under the new legislation, qualifying small businesses must demonstrate less than $5 million in gross receipts for the year the credit is claimed and have no more than five years of gross receipts.

Understanding the Basics of the R&D Tax Credit

Understanding some of the core rules and regulations surrounding this program can help you determine how to best leverage its benefits. The first step in knowing how the credit works is recognizing if your organization qualifies. Some of the preliminary R&D tax credit qualifications include a business that:

  • Develops or designs new processes or products
  • Improves or enhances already existing processes or products
  • Develops or enhances already existing software formulas

How to Claim the Research and Development Tax Credit

Of course, qualifying for the credit isn’t enough. It’s also critical to understand the factors involved when claiming the benefit. To claim the research and development tax credit, eligible taxpayers must systematically assess and document all research activities to establish the total costs of each operation.

Some taxpayers assume they can estimate their overall expenditures. However, it’s essential for these entities to base their claims on detailed and documented practices to optimize the benefit and ensure they have everything needed for proof in the event of an audit. Standard documentation often includes payroll records, expense reporting, project details, as well as any documents created throughout a development project or initiative.

Contact Acena Consulting Today

The best way to understand how the R&D tax credit works is to partner with an accounting team that specializes in identifying and documenting qualifying research activities. Contact Acena Consulting today to learn more.



Randy Eickhoff

Randy Eickhoff

Acena Consulting President Randy Eickhoff, licensed CPA, has partnered with more than 200 companies during more than 20 years of experience securing tax credits and other government incentives. His corporate partners range from multinational technology firms to smaller, privately held manufacturing, sports, and technology enterprises.