R&D Tax Credit Qualified Research Expenses (QREs)
Businesses in the United States can cut down on their taxes to increase the overall after-tax cash flow. Later, the saved amount can be utilized to work on its productivity. However, some businesses are unable to identify their R&D tax credit qualified expenses. Hence, they end up paying more taxes, lowering their income.
What Is R&D Tax Credit?
Introduced in 1981 by the federal government, the R&D or Research and Development Tax Credit is a credit on your income tax return. As the name suggests, the R&D tax credit serves as an incentive to promote researches that lead to overall product development or improvement.
States provide this credit to enhance the potential benefit of state or federal government about 10-20% of qualified spending.
IRC or Internation Revenue Code covers the regulations for the R&D Tax credit in section 41 of the documents.
The credit is given out on specific research, QREs, and qualified research expenses. QREs help businesses identify which expenses meet the criteria for tax reduction.
Advantages of R&D Tax Credit For a Business Entity
Businesses can derive numerous benefits from R&D tax credit if they are well aware of their qualifying expenses. However, their specific advantages depend upon the type of business.
In the case of for-profit organizations, R&D credits will result in a decreased liability of federal income tax. Therefore, a reduction in tax liability results in the rise of the overall company earnings.
Secondly, Eligible Small Businesses can also apply for R&D credits against Alternative Minimum tax. On the other hand, Qualifying Small Businesses can utilize its credits to cancel out payroll tax charges up to $250,000.
the leftover credits can be saved for up to 20 years for future consumption against taxes. Hence, the cash flow of firms can be maintained even in case of a scarcity of funds.
R&D Tax Credit Calculation Method
To calculate R&D tax credit, you might opt for one of the two techniques; Alternative Simplified Credit or Regular Research Credit. You can use whatever procedure serves you better and proceed to get your credits.
method, i.e., the Regular Research Credit may be calculated by determining 20% of the qualified expenses for the current year that surpassed a standard amount. The degree of simplification of the calculation depends on how old or new you are in the corporate world.
Next, the Alternative Simplified Credit takes into account the previous 3 years. Hence, if you have just started, this is not an option for you. To calculate R&D by this method, take 14% of the difference between the number of qualifying expenses for the ongoing year and 50% of the average qualifying expenses for the previous 3 years.
What is meant by Qualified Research Expenses?
Qualified Research Expenses or QREs are growth stimulators of a business. Simply put, QREs are the costs incurred while working on or developing products, improving procedures, enhancing business quality, etc., that align with the specific requirements set by the IRS.
According to section 41 b, QREs are obtained by adding “in-house research expenses” and “contract research expenses .” This means that QREs help businesses identify which expenses meet the criterion for tax reduction.
Which Expenditures qualify for R&D Credit?
The following expenses qualify for R&D credit:
Wages refer to the salaries paid to people directly involved with the development and modification of the product. Also, supervising R&D activities, supporting the development, etc., will be included in qualifying expenditures. However, non-qualified activities are not eligible for any credit consumption.
The right way to divide up wages for r&d tax credit qualified activities is to divide qualified activity hours (for a year) by the total hours of all activities (for a year) and multiply it by employee wages for the entire year. If the answer to your calculation exceeds 80%, then all employees’ wages will be qualified expenditures for the taxable year.
For R&D Credit, employees need to submit the following:
· Time records
· Employee form W-2s
· Meeting Minutes
· Payroll record
· Oral testament
Supplies are any personal asset (not subjected to depreciation) that is used to carry out qualified research. Precisely, any items used to develop the product will be termed “supplies.” However, to qualify, the supply item must be directly linked to the research process.
Typically, Supply QREs represent only a small portion of the total qualified research expenses. One must be mindful not to include any depreciable item or other ineligible expense to the claimed QREs.
Examples of Ineligible expenses include:
· Repositioning or rent expense
· Entertainment expenses e.g., travel, food, etc.
· License expenses
· Phone bills
Contract Research Expenses
In simple terms, Contract Research Expenses includes 65% of any expenses incurred by a taxpayer to someone else to carry out qualified research. However, that someone must be anyone other than the employee of the taxpayer himself.
Determining contract research expenses is the most fundamental research credit issue. Nevertheless, the subject gets ignored sometimes. Businesses must ensure they add contract expenses to supplies and wages to determine the correct figure for Qualified Research Expenses.
Which Expenditures Don’t Qualify For R&D Credit?
Several expenses won’t fall in the category of QREs; they include:
· Conduction of any process similar to an existing one
· Research Activities carried out outside the concerned state
· Economic/Social Research
· Quality Maintenance Activities or Expenses
How To Claim R&D Tax Credit?
Generally, people think claiming an R&D tax credit is a tedious process. Businesses tend to overpay taxes than claim R&D credits. However, the process requires a proper set of documents for the claiming process. The correct documents include:
- Records of payroll
- Accounting records of the project
- Pass the 4 Part Test of IRS
- Sample design, patent applications, project documents, etc.
If you wish to acquire R&D tax credit for your trade or business, you need to get done with collecting documents beforehand. Once the tax filing season passes, it will take more time to claim your R&D credit. Once you have the documents in hand, you will be good to go.