If you're a business owner or entrepreneur, you may be eligible for the research and development (R&D) tax credit. This credit can help offset the costs of developing new products or services, and it can be a valuable way to reduce your tax liability.
To claim the research credit, you'll need to file IRS Form 6765. This form can be complicated, so it's important to understand the instructions before you begin. The calculation can be complex depending on your situation but in simplest terms: The R&D tax credit calculation involves determining your qualified research expenses (QREs) and multiplying them by the appropriate credit rate.
Like many government-backed tax programs, the research and development tax program is both complicated and ever-evolving. Many business owners struggle to stay up to speed on the latest requirements and regulations. As a result, it's challenging to calculate the R&D tax credit without the help of a professional tax team that specializes in research and development documentation.
Qualified Research Expenses: Know the Basics of Form 6765
Partnering with a skilled R&D tax credit firm is the best way for qualifying businesses to optimize the cash flow opportunities and incentives offered through the Section 41 benefit. However, entrepreneurs and executives must still be part of the process. Beyond recognizing the qualified research expenses (QREs) that your business incurs throughout the year, you should also be familiar with IRS Form 6765.
IRS Form 6765 Instructions
Form 6765 is required for all businesses filing for the federal research and development tax credit. This government document is separated into four sections. Qualifying taxpayers will fill out section A or B as well as C and, potentially, D. A basic breakdown of each section on Form 6765 includes:
Section A: Regular Credit
Claiming Regular Credit for research and development projects can be complex. However, a simple definition of the calculation is that the Regular Credit is 20% of the taxpayer's current-year QREs in excess of a calculated minimum base amount.
Section B: Alternative Simplified Credit
As its name implies, the Alternative Simplified Credit (ASC) offers taxpayers an alternative method to calculate available research and development tax credits. Additionally, the ASC broadens eligibility for many business owners, allowing organizations to claim the credit even if their current year expenses don't meet the regular credit calculation threshold. Unlike the regular credit's 20% rate for current-year qualifying research expenses, the ASC rate is 14% of the total of QREs that surpass 50% of the average QREs for the previous three tax years.
Note: The best way to determine whether your business should complete Section A or B is to run the calculations for both, opting for the method that yields the biggest final credit benefit.
Section C: Current Year Credit
After you've calculated your business' current-year research and development tax credit in either Section A or Section B of Form 6765, you can fill out Section C to identify any additional forms and schedules that warrant reporting based on your business structure.
Section D: Qualified Small Business Payroll Tax Election and Payroll Tax Credit
The R&D tax credit is not only applicable to income taxes but can also be applied against payroll tax liability, reducing the amount a business owes. This benefit, known as the payroll tax credit, can provide significant savings to eligible businesses.
Payroll tax liability is the total amount of taxes a business owes based on employee wages, including Social Security, Medicare, and federal and state unemployment taxes. It's essential to accurately calculate your payroll tax liability to ensure compliance and avoid penalties.
Section D only requires completion from taxpayers making the payroll tax election for their small businesses. To make the payroll election, a company must meet the requirements of a Qualified Small Business, which includes having less than $5 million in revenue and no revenue five years prior to the year in which the election is being made. Designated small businesses can apply as much as $500,000 of research credits to offset payroll tax obligations.
However, you have to elect this option on an originally filed tax return — meaning if you missed out applying the R&D credit to payroll taxes in a prior year, you can't correct your mistake by filing an amended return.
R&D Tax Credit Calculation Example:
To provide context for how the research and development tax credit works, Let's say that a business has $1 million in qualified research expenses (QREs) in the current year. Assume the calculated base amount is $700,000 (based upon a fixed base percentage and the prior four years' average revenues). Two calculations are performed to determine the amount to use for the credit calculation. The lower result is used to determine the amount of the credit:
Step 1:
$1 million - $700,000 base amount = $300,000
Step 2:
$1 million x 50% - 500,000
Step 3:
Take the lesser of the results of Steps 1 & 2 from above:
$1 million - $700,000 = $300,000
Step 4 - credit calculation:
$300,000 x 20% = $60,000 credit (no reduced credit amount election taken in this example)
Under the Alternative Simplified Credit method, the calculation would be:
Let's assume the same facts as above for the current year's QREs of $1 million and an average QRE expenditure over the last 3 years of $750,000.
$1 million - $375,000 (50% of the average prior three years gross receipts) = $625,000
$625,000 x 14% = $87,500 credit available to offset taxes.
Note: This is only a simplified example for demonstration purposes. There are many other factors that can affect the final credit calculation, so it's always best to consult with an experienced R&D tax professional.
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Need Help? Contact Acena Consulting Today
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