KPMG Spark Blog

How to Know If Your Small Business Qualifies for the R&D Credit

The Research and Development (R&D) tax credit is a tax incentive for companies that perform qualified research in the U.S. Let's take a closer look at this tax credit and see how it can help your business.

The Research and Development (R&D) tax credit is a tax incentive for companies that perform qualified research in the U.S. While the term R&D tends to conjure visions of research labs and test tubes, a wide range of businesses and activities qualify for the credit.

Overview of the R&D Credit

The R&D credit is available to companies that spend money in an attempt to develop new or improved products, processes, software, techniques, or formulas.

If your activity qualifies, the federal tax credit is worth 11% to 15.8% of Qualified Research Expenditures (QRE) above a base amount (often about half the current QRE), which includes:

●        Wages of employees directly conducting or supporting the innovation and first-line supervisors

●        Supply costs, including tangible property and prototypes

●        Contract research expenses paid to third-party vendors, consultants, contractors, and temporary employees (at 65%)

●        Patent development costs

●        Costs to rent or lease computers or cloud services used in the research and development process

Over 35 states in the U.S. have enacted their own R&D tax credits, making this an extremely valuable tax incentive for companies that can claim it.

What business activities qualify for the R&D credit?

The IRS has a four-part test to help small businesses decide whether their activities qualify for the R&D credit:

  1. Permitted purpose. The purpose of the research or development must be to create a new or improved product or process that the business intends to sell, lease, license, or use in its business operations.
  2. Technological in nature. The experimentation process must rely on the hard sciences, including engineering, computer science, physics, chemistry, or biology.
  3. Technical uncertainty. The business must perform the research to eliminate technical uncertainty about the development or improvement of a product. In other words, purely aesthetic changes don’t qualify.
  4. Process of experimentation. The activities must include experimentation via modeling, simulation, systematic trial and error, or other methods.

Internal-use software, that is software used for general and administrative purposes of the taxpayer, must pass an additional three-part test:

1.       it must be innovative;

2.       It must involve significant economic risk, and

3.       It must not be commercially available without mpdofocati0ons that involve innovation and significant economic risk.

Any company in any industry that devotes resources toward research and development may qualify for the R&D credit. However, a few common examples include software and tech companies, construction contractors, manufacturers, food processors, and healthcare companies.

Some of the activities that qualify include:

●        Developing new or improved products or manufacturing processes

●        Developing new or improved software applications for sale, lease, or license

●        Building and enhancing interactive software-as-a-service (SaaS) platforms and web applications

●        Creating algorithms to automate tasks resulting in increased performance

●        Writing code to add functionality and capabilities to improve existing applications

●        Programming mobile apps for iOS and Android platforms

●        Developing code for new technologies such as artificial intelligence, blockchain, and machine learning

It’s also useful to note that the research doesn’t have to be successful for the expenses to count for the credit.

Benefits of an R&D study

If you believe your business may qualify for the R&D credit, an R&D Tax Credit Study can help alleviate complexity and ambiguity by analyzing your company’s research and development activities and determining which costs qualify for the credit.

These studies offer three primary benefits:

1.   Improved cash flow

The R&D tax credit can offset your current year’s federal (and possibly state) income tax liability. If the available credit is greater than the tax due, any unused credit can be carried back one year or carried forward 20 years. We may also be able to identify prior year returns that may be amended to claim the credit retroactively.

New small businesses also have the option of applying up to $250,000 of their federal R&D credit to their payroll tax liability for up to five years.

2.   Financial statements

Claiming the R&D tax credit can reduce the tax provision on your books, resulting in increased net income and higher earnings per share (EPS).

3.   Defense

Analyzing and documenting your business’s research and development activities is essential to ensuring the credit will hold up under audit scrutiny from the IRS and state tax authorities.

For many companies, most qualifying R&D expenses stem from employee and wages and contractor fees, so it’s important to document exactly how much time employees and contractors spend working on qualifying activities. A quality R&D tax credit study is the best offense in sustaining the credit.

Don’t leave money on the table! KPMG Spark is in your corner, helping your business take advantage of available tax incentives. Our professionals can help you navigate your finances, from accounting for daily transactions to filing tax returns. Schedule a consult to learn more and find out if Spark is the right fit for your business.

 

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG LLP.

This blog article is not intended to address or provide advice concerning the specific circumstances of any particular individual or entity and does not constitute an endorsement of any entity or its products or services.

Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.

The following information is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

KPMG SparkJune 8, 2021Posted In: Tax Tips

Subscribe

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.

KPMG Spark is an online accounting service that saves you time so you can focus on what’s most important for your business.

Hiring Help: How To Know Whether To Hire an Employee or Contractor?

There are many important differences between an employee and an independent contractor that can affect the financial foundation of your business. Continue reading to learn some of the financial impacts you should consider when making this decision.

KPMG SparkSeptember 22, 2021Posted In: Business Tips

Selecting an Entity Structure Helps Build a Strong Financial Foundation for Your Business

Running a successful business depends on a solid financial foundation. You can have the most sought-after products or services, a killer marketing strategy, and loyal customers, but if you don’t have a solid financial foundation to manage cash flow and support other business decisions, it can all come crumbling down. Continue reading to learn how selecting an entity structure can help build your financial foundation.

KPMG SparkSeptember 1, 2021Posted In: Business Tips

Real-Time Bookkeeping: 5 Valuable Insights You Can Gain From Real-Time Bookkeeping

Real-time bookkeeping uses live data to give you visibility into your current income and expenses, balances, and more. The visibility that real-time bookkeeping provides allows business owners to gain valuable insight into both their finances and businesses. Continue reading for 5 valuable insights you can gain from real-time bookkeeping.

Alexandra OjalvoAugust 24, 2021Posted In: Tax Tips

The importance of having a personalized bookkeeper

Having a personalized bookkeeper can provide valuable benefits to any business owner. A personalized bookkeeper can monitor and organize your business’s daily transactions. Not only that, they can also give you the reassurance and security you want to have about your company’s finances. Join us to learn more about the importance of having a personalized bookkeeper.

Aubry BlackAugust 17, 2021Posted In: Business Tips

Making the Most of Restaurant Relief Funding

Beyond predictable product expenses, some restaurants might opt to use the Restaurant Relief funds to better adapt to a post-pandemic dining culture that will likely continue to expect extra sanitization, more outdoor seating, and ample distance between tables—all of which have associated costs.

KPMG SparkAugust 10, 2021Posted In: Tax Tips

How I Am Kid Culture Teaches Youth About Intrinsic Value

Wrongfully imprisoned for 25 years, founder Patrick Pursely uses KPMG Spark to help keep his organization operating as a registered nonprofit.

KPMG SparkJuly 27, 2021Posted In: Client Stories

5 Steps to Successful Remote Hiring

Remote work isn't new, but it seems to have now shifted from a rare perk to the norm for many businesses. This change has many benefits for small businesses. Remote work now allows business owners to find the best talent regardless of their location. However, hiring remotely is different from in-person hiring, and small business owners need to know how to approach the process.

KPMG SparkJuly 20, 2021Posted In: Business Tips

Client Story: It’s the Little Things That Count

How innovation and KPMG Spark have helped this family-owned pen company provide opportunities for adults with disabilities.

KPMG SparkJuly 14, 2021Posted In: Client Stories
Image of person doing bookkeeping at a desk

Why Is Bookkeeping Important In 2021?

Starting a business can be a busy time for any entrepreneur and to some, worrying about bookkeeping can seem like an unnecessary task. But, as intimidating as it may be to have a bookkeeper, there are many benefits to online bookkeeping and a strong accounting platform; and several problems can arise when a business does not keep their bookkeeping up to date.

KPMG SparkJune 29, 2021Posted In: Accounting Info