The detrimental impact of the ongoing pandemic on the global economy has seriously put the prospects of mushrooming growth and development at stake. Businesses are desperately attempting to seek solutions for survival. Moreover, the greater risk of bankruptcy has caused the businesses to look at governments as the last resort for financial assistance. In order to provide financial relief to businesses, many countries have stimulus programs in place, but many of these programs only cover a short time frame and are due to expire soon.
However, countries like the USA and Canada spend billions of dollars annually to provide funding in the form of the R&D tax credit to innovative businesses. This is an ongoing program that does not expire. The goal of this funding program is to enable businesses to innovate and compete in the global market while enabling them to create new jobs and retain existing ones. US startups can get a refund check of up to $250,000 per year by applying the R&D tax credit to offset social security payroll taxes.
However, the major bottleneck with respect to the application process is that it takes a lot of time and the program requirements can be confusing.
You can get back 10% of your qualified research and development costs through the US Federal R&D tax credit. In addition to the Federal program, every State has its own R&D tax credit rules.
There are two ways the R&D tax credit can be used to fund your business and impact your bottom line:
1. You can use the R&D tax credit to lower your tax liability if your business is profitable and you will owe corporate taxes.
2. If your business is not profitable, you can utilize your R&D tax credit to offset up to $250,000 in social security payroll taxes and get a refund check from the IRS. To qualify for the social security payroll tax offset, you need to have gross receipts/revenues of less than $5 million for the tax year, and have gross receipts/revenues for five years or less from the tax year.
For example, if you are a startup that is paying $750,000 to engineers to develop new software, you could potentially get $75,000 as a refund check.
Many companies are deterred by applying for the R&D tax credit program because they incorrectly assume it only applies to companies with scientists working in a lab. That is far from the truth as the program is designed to support research and experimentation in all arenas, from life science and manufacturing to software development, agriculture and beyond, to enable businesses to increase revenue and growth.
Below is the 4-part qualifying criteria for the R&D tax credit as outlined in the US tax law.
1. Develop new or improve existing functionality, performance, reliability, or quality of a product, process, technique, invention, formula, or computer software for the purpose of sale, lease, licence or use in your business.
2. Eliminate uncertainty during the research and development process that you couldn’t resolve using publicly available information.
3. Utilize a systematic process of experimentation to evaluate one or more alternatives in order to eliminate uncertainties and achieve the desired end result.
4. Utilize principles of engineering, computer science, or physical or biological sciences.
For example, in software companies, some areas of potential qualifying R&D work include, developing new software from scratch, adding new features to existing software, integrating applications that were not designed to communicate with each other, improving software application response time, speed or throughput, developing artificial intelligence and machine learning algorithms, developing blockchain technologies, etc.
Firstly, you can claim employee salaries for those who perform or directly supervise or support qualified research and development activities in the US.
You can also claim contractor costs if you’ve outsourced some of your development activities. It is important to note that the contractors need to be working in the US and your company needs to retain the rights to the R&D and associated intellectual property resulting from their work.
Other expenses you can claim include hosting costs incurred for Microsoft Azure, Amazon Web Services, Google Cloud, etc. as well as the cost of supplies used in research and development, including extraordinary utilities, excluding capital items or general administrative supplies such as travel, shipping, or royalty expenses.
Preparing the R&D tax credit application on your own can be stressful and a distraction from your business as the first step is to properly study the IRS tax guidelines.
You then need to identify all the research and development activities undertaken by your company in the tax year that would qualify per the guidelines.
Then you need to identify employees that worked on those activities and prepare time estimates for them.
You also need to identify other associated research and development expenses such as contractors, hosting costs, and supplies, and have evidence to show that they were required for the R&D tasks.
Lastly, you need to prepare necessary supporting documents and tax forms.
There is a lot of money at stake here and we recommend using an R&D Tax Credit Software with a team of experts like Boast.AI or contacting a tax credit expert.
Ibrahim is our regular contributor. He loves to write very much. He is passionate about crypto and gaming.