How does the R&D credit apply?

The advent of major technological innovations — such as rapid prototyping using 3D printing, simulation software, and pervasive wireless connectivity — has opened doors to rapid advancement in a variety of sectors. For example, companies can include 3D printing materials for prototypes in the credit calculation in addition to sensors, actuators, and other electrical components. They can also include raw materials such as metals and other consumables they use during development. Additional expenses that may qualify for the R&D credit include: Employee wages for those that engage in research, as well as those that directly supervise or support the research Supply expenses for materials used or consumed in the performance of R&D Cloud computing expenses for shared computer rental or cloud platforms that aid in development-related tasks Expenses to engage third-party companies that perform development-related tasks, both physical and intellectual, that require a degree of specialized knowledge When considering employee wages, it’s important to assess the impact of highly compensated employees on the credit, with an emphasis on those in executive roles. Technology companies often scale rapidly, so compensation can rise quickly with company revenues and the IRS may closely scrutinize the executive’s activity as well as the reasonableness of wages allocated to the credit. Claiming the credit may require additional proof of executives’ qualified services, such as technical documentation, emails, and calendar appointments pertaining to R&D.

What activities within the technology industry qualify for the R&D credit?

Technology companies tend to be experimental in nature, so many activities in developing new products and processes may potentially qualify for the credit. For example, evaluating technical considerations and advantages or disadvantages with respect to creation of product designs, material selection, formulations, or manufacturing processes happen frequently during the development or product improvement cycle. These tasks may entail a variety of testing methods to assess efficacy, such as structural tests, durability, or destructive testing, all of which may qualify for R&D credits. Some of the specific activities that could qualify include the following: Designing and testing prototypes and pilot models Introducing new technologies to improve the manufacturing process Testing alternative materials to improve product performance and manufacturing Designing new or improved software platforms, applications, or features Adding new capabilities or enhancing the functionality of existing software to create a competitive advantage Creating software in which scale and complexity present technological challenges Creating specialized technologies, such as artificial intelligence or machine learning Developing software applications to use internally or to interact with customers or vendors

What’s the next step to apply for these credits?

When seeking the R&D credit, it’s important to remember that you need a certain level of documentation to successfully claim the credit — and mistakes can incur penalties. First, collect preliminary information about your company’s potential qualified activities and expenses, which will help estimate the credit benefit. Next, you’ll want to formulate a plan for calculating and documenting the credits, which may involve analyzing detailed financial data, interviewing technical personnel, and gathering additional records to support claiming the credit.

Article

A closer look at R&D tax credits for technology companies

Sept. 23, 2021 · Updated Nov. 9, 2023 · Authored by Vanessa Oviatt, Travis Riley

Innovation fuels the technology industry, making it a natural fit for R&D tax credits.

As the breadth and depth of the start-up ecosystem in the United States has grown, the number of companies that could benefit from tax policy favoring continued investment in start-ups has also increased. However, improperly calculating and claiming R&D credits can have consequences in the form of penalties and fines.

What is the R&D tax credit?

The R&D tax credit is a dollar-for-dollar tax savings that directly reduces a company’s tax liability. There’s no expense or credit limit a company can generate each year. If the company can’t use the R&D credit immediately or completely, they can generally carry them over to prior or future years.

In addition, a company can typically amend previously filed tax returns to claim the R&D credit retrospectively, providing an avenue to recoup previously paid taxes. New companies may also be eligible to apply the R&D tax credit against their payroll tax during their start-up years.

To help break down this complex topic, here’s a list of common questions technology companies often ask about the R&D credit.

How much can a company save with R&D tax credits?

There’s no limit, but several factors can impact savings — and because there’s such a wide variety of qualified expenses within the technology industry, it’s difficult to give an exact estimate of potential savings. Qualified small businesses can use up to $500,000 to offset employer payroll taxes if specific requirements are met.

Depending on a company’s size and the types of activities performed, typical savings can range anywhere from $50,000 to $5 million through the R&D tax credit.

The amount saved stems from the amount of expenses determined eligible for the credit, not the revenue a company generates. Generally, the amount of credit can be approximately 5%–15% of a company’s R&D expenses during a given year. Typically, the more a company spends to innovate, the more they can potentially save.

Vanessa Oviatt

Managing Director

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.