The Research & Experimentation Tax Credit is a general business tax credit under the IRS Code section 41 for companies that incur research and development (R&D) costs in the US. In 2015, the US government made the tax credit permanent.
This tax credit is an incentive for businesses to engage in R&D and develop new products. The tax credit allows qualified businesses to recoup up to $250,000 in payroll taxes. One of the key benefits for small business is the provision that you can use third-party development costs, so long as you maintain the rights and risks of the R&D.
There are several criteria to keep in mind if you are looking to claim the credit; below is a concise summary of some of the key criteria to take into consideration if you choose to review this benefit with your CPA.
You are a for-profit enterprise.
Are you a small business, as defined by the IRS, with as annual revenue less than 5MM, and have not exceeded 5MM in annual revenue in the past 5 years?
All research must be completed on US soil.
In considering the tax credit there is a four-part test:
Permitted Purpose—The R&D costs incurred are for an IRS permitted purpose. The costs are intended to improve functionality, quality, reliability or performance of your product.
Uncertainty—The R&D is designed to answer uncertainty; in other words, you must perform research in order to discover information that will answer the uncertainty.
Experimentation—There must be some level of uncertainty when you start the development as you are required to conduct this R&D to solve a problem.
Technology—The R&D must be technological in nature, using science and/or forms of engineering in the work.
The R&D credit applies to more than just companies like Facebook who are developing totally new products for the masses. The R&D credit applies to any business that uses scientific methods to develop new products and ideas. This means that your neighborhood Architect, Civil Engineer, Craft Brewery, Structural Engineer, Winemaker, or other custom product designer could qualify. The R&D credit is not overly common and not every tax preparer or CPA firm has a lot of knowledge about this credit. The R&D Tax Credit is an item every entrepreneur should keep in their knowledge base and ask their CPA about it if they can potentially qualify to claim this particular credit.
For further reference please see, IRS Form 6765 and Notice 2017-23.