Friday, January 16, 2015

Business Tax Credits: The Research and Development Tax Credit

Business Credits

Business credits are not just for the big boys like Apple, Inc. and Google, Inc. but they can mean thousands of dollars for your business. Business credits are not widely discussed nor is much information published by the IRS on the subject. As a result many businesses are "leaving money on the table". If you own a business you do well to find a CPA that has working knowledge of business tax credits.

For example, does your business have research and development expenses for developing new products? If so it is likely that your business qualifies for the Research and Development Tax Credit. In Amy Feldman's recent article in Inc. "The Essential Startup Guide to Tax Time" she mentioned a situation where an app developer discovered that they qualify for the research and development tax credit. They found by amending their prior three years of tax returns for the credit that they got $30,000 in taxes back. To my small business clients that qualify for the research and development tax credit as well as the tip credit these credits are worth thousands of dollars a year to them. Your business too may qualify for these credits and that may mean thousands of dollars for you and your business.

How They Work

Credits are really powerful on your tax return because they do more than simply reduce taxable income they reduce actual taxes.  So say a business has $100,000 in qualified R&D expenses and based on the calculation they are (as an example only) entitled to a credit of $14,000 which will actually reduce their taxes dollar for dollar so it means a $14,000 reduction in taxes.  So what is The Research and Development Tax Credit? Who can take the credit and how is it calculated?

What is The Research and Development Tax Credit

The IRS describes the credit as a credit for increasing research activities. If your business has qualified research and development expenses the business may be entitled to the credit. The following is included in the definition of  qualified research expenses provided by the IRS with form 6765:

Qualified research means research for which expenses may be treated as section 174 expenses. This research must be undertaken for discovering information that is technological in nature, and its application must be intended for use in developing a new or improved business component of the taxpayer. In addition, substantially all of the activities of the research must be elements of a process of experimentation relating to a new or improved function, performance, reliability, or quality. All of the research activities must be applied separately with respect to each business component of the taxpayer. The research credit generally is not allowed for the following types of activities.
• Research conducted after the beginning of commercial production.
• Research adapting an existing product or process to a particular customer’s need.
• Duplication of an existing product or process.
• Surveys or studies.
• Research relating to certain internal-use computer software.
• Research conducted outside the United States, Puerto Rico, or a U.S. possession.
• Research in the social sciences, arts, or humanities.
• Research funded by another person (or governmental entity).

Who can take the credit

Interestingly software and app developers can qualify for this credit. Any business, individual, estate or trust who has qualified research and development activities may qualify for this credit. Pass through entities, whose profits are passed through to their shareholders/members, can also take the credit and pass it through to their shareholders/members.

Please note there are special rules and whether or not you can take the credit depends on your facts and circumstances.

I found it very interesting too that the qualified expenses are only for research and development conducted in the United States, Puerto Rico, or a U.S. possession.  So the companies that do their research and hold patents in other countries to avoid U.S. taxes can not also benefit from this theory.

How is it calculated

There are two ways to calculate the credit, the regular credit or the alternative simplified credit (ASC). Many small businesses will elect the ASC.  The ASC basically takes your current year qualified research expenses and subtracts half of the average of your qualified research expenses from the last three years and then gives you 14% of that number as a credit.


Obviously your business will need to document its qualified research expenses.  In the event of an audit the IRS will be very interested in your documentation to make sure you are only taking the credit you are entitled to.  You ought to keep records of the work done and be able to show a direct link to the research versus other non research work or expenses.

Amending prior year returns

Businesses with qualified research and development expenses can go back and amend their prior three years of tax returns and potentially get back significant money.  So it is imperative to act quickly to be able to go back and amend all three years.  For example to amend corporate returns for 2011 to 2013 a business may need to amended their return for 2011 by this March 15th filing deadline.  So act quickly and contact me to take advantage of this opportunity.


Unused business credits may be carried back one year or carried forward 20 years.

Regarding use of this credit to make mergers and acquisitions more attractive Karen Klein explained in her Business Week article on "The R&D Tax Credit Explained for Small Business":
"Because the credits can be claimed in one year and taken in another year, they can be transferred to new ownership. The credits also legitimize a company’s technology. A lot of small companies claim the credit every year because they are looking to be acquired by a larger corporation, and if they have R&D credits on their books it proves they have technology someone else is likely to want."

Benefit Like The Big Boys

You too can use business credits like the big boys, Apple Inc. and Google Inc., if you meet the qualifications.  You do not have to be a huge publicly traded company or have a team of CPAs to profit from these credits.  You could be leaving thousands of dollars "on the table."  If you have research and development expenses or have employees that receive tip income that is reported on their W-2 you should contact me to find out how I can help you to benefit from Business Tax Credits. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero

Follow the CPA Superhero on Twitter too at:

My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.