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Enacted in 1981 to encourage research and development (R&D) activities in the United States, the R&D tax credit reduces tax liability for organizations that perform certain activities to develop new or improved products, processes, software, techniques, formulas or inventions.

Because of the broad definition for qualified activities, businesses from almost every industry have claimed R&D tax credits. A business can get about 10% back on qualifying expenses such as wages, contractor costs, cloud hosting and infrastructure, supplies, and legal costs.Partner quote from current website

The R&D tax credit is available to companies developing new or improved business components, including products, processes, computer software, techniques, formulas or inventions, that result in new or improved functionality, performance, reliability, or quality. It’s available at the federal and state level, with over 30 states offering a credit to offset state tax liability.

It’s a dollar-for-dollar tax savings that directly reduces a company’s tax liability. There’s no limitation on the amount of expenses and credit that can be claimed each year. If the federal R&D credit can’t be used immediately or completely, then any unused credit can be carried back one year or carried forward for up to 20 years. Each state has its own carryover rules.

The R&D tax credit regularly provides a wide range of businesses with a source of extra cash—up to 10% of annual R&D costs for federal purposes and much more when state credits are factored in.

The R&D Payroll Credit was created by The Protecting Americans from Tax Hikes (PATH) Act of 2015, which made the R&D credit permanent and expanded its application to create a potential tax benefit for small businesses and start-up companies.

Start-up companies and small businesses may be eligible to apply up to $1.25 million—or $250,000 each year for up to five years—of the federal R&D credit to offset the Federal Insurance Contributions Act (FICA) portion of their payroll taxes each year.

To be eligible, a company must meet two requirements:

• Have less than $5 million in gross receipts for the credit year
• Have no gross receipts or interest income dating back more than five years

The R&D credit is calculated on the federal income tax return as usual and may be applied against payroll taxes starting the quarter after the credit is elected. For calendar-year taxpayers, the R&D credit can be applied against payroll taxes as early as April of the following year.

The payroll-tax offset allows companies to receive a benefit for research activities even if they aren’t profitable.

To be eligible for the credit, companies must meet the following qualifications:

1. Have gross receipts for five years or fewer—interest income counts toward gross receipts
2. Accumulate less than $5 million in gross receipts in the year the credit is elected
3. Conduct qualifying research activities and expenditures
4. Determine they have payroll-tax liability

Regardless of industry, companies are potentially eligible for the R&D credit if their activities meet the following requirements, known as the four-part test:

1. Technical uncertainty. The activity is performed to eliminate technical uncertainty about the development or improvement of a product or process, which includes computer software, techniques, formulas, and inventions.
2. Process of experimentation. The activities include some process of experimentation undertaken to eliminate or resolve a technical uncertainty. This process involves an evaluation of alternative solutions or approaches and is performed through modeling, simulation, systematic trial and error, or other methods.
3. Technological in nature. The process of experimentation relies on the hard sciences, such as engineering, physics, chemistry, biology, or computer science.
4. Qualified purpose. The purpose of the activity must be to create a new or improved product or process, including computer software, that results in increased performance, function, reliability, or quality.

The payroll-tax offset is currently available for qualified expenses incurred during the prior tax year. The R&D credit must be calculated and shown on a taxpayer’s federal income tax return with the portion of the credit applied to offset payroll taxes identified and elected when the return is filed.

The offset is then available on a quarterly basis beginning in the first calendar quarter after a taxpayer files their federal income tax return.

The R&D credit can be applied against payroll taxes beginning the quarter after the credit is elected. For example, if you file for the credit in Q1, your client will receive a credit to offset their payroll taxes beginning in Q2, and for every quarter until the credit has been fully consumed. However, the exact timing and method of payment depends on your client’s payroll provider.

This is dependent on your client’s payroll provider. Please check with their payroll provider to confirm how the R&D tax credit will be refunded.