March 31, 2020

Qualifying Activities for R&D Tax Credits

Small Business
By: Ronald B. Allen

The research and development your company carries out may qualify you for a tax deduction. But, it must be carried out in the USA and it needs to satisfy a number of requirements. At Exigo Business Solutions in the Kansas City area, we help businesses benefit from R&D tax credits, especially since significant changes to the law in 2015 made it more beneficial to startups and small businesses. Here is a quick look at what are research and development tax credits qualifying activities. For a more comprehensive look at R&D and the research and development tax credit contact us for help.

Research and Development Tax Credits Qualifying Activities

First and foremost, to be eligible for tax credits, all R&D must take place in the USA. And, there are several strict rules in regard to the kinds of research and the costs that are covered.

Kinds of R&D Expenses Covered

Wages: for work done by employees for qualified services and including amounts equal to wages for withholding in federal income tax

Supplies: Must be tangible property and not include land, property, or improvements on the same. And, must be consumed and used in the process of doing R&D

Contract Research: This can be money paid to any third party providing that it carries out qualified research activities (QRA) for the taxpayer. This work is allowed but at 65% of the cost incurred. It can also be basic research that a qualified educational institution or research organization carries out on behalf of the taxpayers. This work qualifies for 75% for the cost incurred.

Nature of the R&D Work

In order for your R&D to qualify for tax credits, it needs to meet these criteria.

Process of experimentation with testing and evaluation designed to “eliminate technological uncertainty.”

Intended to “resolve technological uncertainty” that exists in the beginning. This uncertainty must be related to a methodology or capability need to improve or develop a component of the business. Or it must be integrally related to the design of such a component.

Must depend on hard science including physical science, biological science, engineering, or computer science.

A new or improved component of a business should be the ultimate goal. This can include processes or products that are new or improved. Defined techniques, formulas, and inventions qualify, providing that they are meant to be used in the business or trade of the taxpayer or sold by the business. Computer software development may qualify but there are additional rules.

Software Development Requirements

There are three rules that apply in order for computer software to qualify for tax credits.

First, software needs to be innovative and result in measurable improvement in speed, efficiency, and cost in such ways that are economically substantial and significant.

Next, the process of software development should entail economic risk and the commitment of significant resources with the recovery of costs being uncertain with a “reasonable time period.”

Last, this must not be a rewrite of software that is commercially available. It must be the case that the taxpayer can only use leased, purchased, or licensed software if significant modifications are made.

How Do You Get Your Tax Credits for Qualifying R&D

In order to receive the R&D tax credit you need to be doing real research and development and you need to document what you are doing, why you are doing it and the costs involved. If this is new to you, contact us at Exigo Business Solutions in the Kansas City area for help setting up your accounting correctly in order to take advantage of this tax deduction.

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