$250,000 Federal Incentive: What is the R&D Payroll Tax Credit?

R&D Tax Credit Summarized

The federal R&D (Research & Development) Tax Credit is also known as the Research and Experimentation (R&E) tax credit. It was created in 1981 to reward businesses who invested in research, with the idea it would foster job growth and encourage innovation of new products. Initially this tax credit was meant to be only a two-year incentive but has become a permanent part of the federal tax code. Under Obama’s Administration, the PATH Act of 2015 was passed which expanded this credit’s provisions and addressed limitations for certain small businesses and startup companies.

Eligibility & Qualifications

Common industries that qualify for this tax credit include, but are not limited to:

  • Software Development
  • Pharmaceutical
  • Automobile
  • Manufacturing
  • Aerospace & Defense
  • Engineering

If you are a smaller organization, keep in mind you do NOT need to be profitable in order to claim the credit. You are eligible to claim if:

  1. You have five years or less of gross receipts before the year in which the credit is claimed
  2. You have less than $5 million in gross receipts in the year the credit is claimed

Expenses for performing Qualified Research Activities in the United States you can claim:  

  • Wages paid to employees
  • Supplies used and consumed in the R&D process
  • Contract research expenses paid to third parties who perform activities on behalf of the taxpayer
  • Equipment costs

There are four simple criteria taxpayers’ R&D programs must meet (according to IRC section 41). 

  1. The purpose of the activity must be to create a new or improved product or process that would result in increased performance and function.
  2. It must have a resolution to technical uncertainty about the development or improvement of a product or process.
  3. Experimentation must be part of the process(e.g. evaluating alternative solutions through simulation, modeling, or trial and error).
  4. The experimentation must rely on science or engineering.

Risks to claiming R&D Credit

Companies who claim the R&D Credit undergo a higher level of scrutiny from the IRS, especially those who claim larger credits. The rules and regulations surrounding the credit are always changing and remain to be complex. IRS can deny credits and impose penalties of more than 20% of the credit amount claimed if, once reviewed and examined, the organization fails to meet the requirements.

Benefits of claiming R&D Credit

With this tax credit to offset your payroll liability, there are many things you can do with the savings. You can hire more, renovate your offices, purchase or lease new equipment, spend more on marketing efforts, hire an adviser, and even improve your workforce management.

Payroll Systems can assist employers with the filing of the R&D tax credit on their quarterly 941. If you’d like to learn more about our payroll and tax services, please contact us today by filling out the form below!

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