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R&D Tax Credit Software: How Do You Calculate R&D Tax Credit?

R&D tax credits are valuable to small companies when it comes to saving money on taxes. Unfortunately, some businesses fail to take advantage of the tax incentives. As to why, it seems that small companies are unaware of it, or they do not believe the incentives apply to them, too. But all businesses can qualify – regardless of the size, as long as they meet the requirements, they will still get something. They can use any available R&D tax credit software to calculate how much they will receive.

Calculating how much a company is entitled to get can be confusing. One thing to note here is that companies must meet certain requirements in order to qualify for tax credits. Here’s everything you must know about this tax incentive – including how to calculate them.

The R&D Tax Credit

The R&D tax credit is a form of incentive for companies in the United States. Its purpose is to promote more investment in research and development in the country by increasing tax refunds or minimizing the amount of taxes owed.

Claiming the R&D tax credit

Any business can claim the tax credit, especially if they use the R&D tax credit software appropriately. If companies invest in the development of new products or in improving processes within the US, they can qualify for tax credits.

How Companies Use the R&D Tax Credit

If your business meets the requirements for the tax incentives, you get to decide when and how you will use it. Many small businesses use the credit against the income tax liabilities of the company. Those that have yet to earn a profit use the incentives to offset the payroll liabilities of the company.

Below is a breakdown of ways companies use the R&D tax incentives to their benefit:

  1. Gaining back 5% to 15% of the funds they have spent on qualifying expenses. While the refund amount mainly depends on the specifics of the business, the R&D tax credit will cover 5% to 15% of any qualified expenses, which means that if you have spent $50,000 on qualified research expenses, you will receive around $2,500 to $7,500.
  2. Making up for payroll taxes. Small companies often use the R&D tax credit to offset payroll taxes, which benefits them significantly. For them to qualify, they must be able to present their gross receipts for the year in question, which should be lower than $5,000,000. Furthermore, they should not have gross receipts from over five years ago.
If they meet the requirements, they can even out up to $250,000 in payroll taxes when they choose this when filing their income tax return. If they qualify for the tax incentives multiple years in a row, they can use the extra amount to pay for a portion of their income tax liability.

  1. Adjusting income tax returns. If companies fail to claim the tax incentive in the previous years, they can still receive it if they qualify. They can adjust their income tax return, which allows them to obtain a refund for that year.
Income tax is non-refundable if the R&D tax credit is bigger than their income tax. However, they can carry forward any unused portions of the credit for up to twenty years.

R&D Tax Credit Software: Calculating R&D Credit

To calculate the R&D tax credit companies will receive, they must provide documentation of their qualified research expenses, which include the following:

  • Contract research expenses – these are presented to a third party that conducts qualified research activities.
  • Expenses towards leasing computers used in research projects or cloud service providers.
  • Materials and supplies used during the development process.
  • Payments to employees who are working on the process of development.
Research activities do not always have to yield successful outcomes for the expenses to qualify. Businesses can still claim the incentives even if the project or research fails.

Calculating the R&D tax credit can be done in two ways - the traditional and the alternative simplified credit method.

The traditional method

The traditional method focuses on 20% of a business’s current year QREs over a base amount. But to get the fix-based percentage, you must divide the QREs for tax years during a base period by the gross receipts (the same period). Then, multiply it by the average annual gross receipts of the company for the four tax years before to the year in which you are calculating the credit. This calculation yields the base amount.

The fixed base percentage should never be more than 16%, and the base amount should never be less than 50% of the QREs for the current year.

Below is how the traditional method calculation works:

  1. Add all the QREs for the current tax year.
  2. Identify the aggregate QREs over a base period.
  3. Divide it by the aggregate gross receipts (same period) to find the fixed-base percentage.
  4. Take 16% or the lesser of the fixed-base percentage.
  5. Multiply it by the average annual gross receipts from the last four years to get the base amount.
  6. Take 50% of the current year’s QREs or the greater of the calculated base amount.
  7. From the QREs of the current year, deduct the minimum base amount.
  8. Multiply it by 20%.
The alternative simplified credit method

Since 2009, the alternative simplified credit method is 14% of QREs companies incur in the current tax year and above 50% of the average QREs in the last three years.

However, if there are no QREs in those three prior years, the calculated credit is 6% of the QREs in the current tax year. Simply put, the alternative simplified credit method works like this:

  1. Determine and calculate the average QREs for the last three years
  2. Multiply the average QREs for that 3-year period by 50%
  3. From the current year QREs, deduct half of the 3-year average.
  4. Multiply the result by 14%
All these calculations can be a little confusing, which is why R&D tax credit software is such a big help these days. Such software will help companies that qualify for the tax incentive to claim it.Image Credits:
Image 1: Images by Images Money on Flickr
Image 2: Image by Steve Buissinne from Pixabay

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Any facts, figures or references stated here are made by the author & don't reflect the endorsement of iU at all times unless otherwise drafted by official staff at iU. This article was first published here on 27th September 2022.

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