R&D Tax Credits Basics you need to know.

Research and development are an essential part of any business. You have to constantly evolve and find better solutions to problems. Almost every company has a research and development team that is tasked with finding better alternatives to existing solutions. An R&D team is responsible for developing new products and services, and improving products. A business should invest in a research and development team, even though its activities do not generate any revenue in the short run.


Research is a long process, it does not happen overnight. The result of the activities conducted by an R&D team may be seen many years later. But during the years of research and development, there are significant costs a company incurs. These expenses include salaries for the research staff, equipment used for the research, materials needed for development, etc. There are no returns earned against these expenses till the time the research is completed, so it is a big cost for the company.


To encourage innovation and development of novel solutions, incentives in the form of R&D tax credits were introduced in 1981. Now, a company can get tax benefits against the expenses incurred on research and development. Corporations save hundreds and thousands of dollars due to these tax credits, as R&D costs make up a major chunk of a company’s expenses. Any company that is spending on developing and creating new products and services or processes can claim the R&D tax credits to reduce its tax burden. But many companies are not taking its benefits, because they don’t know if they are eligible to claim these tax benefits.


Let’s look at what makes a business eligible to claim the R&D tax credits:

  • If your business is engaged in developing a process or designing new products, you can claim R&D tax credits.
  • If your business conducts activities that improve upon existing processes or products, you are eligible for R&D tax credits.
  • If your business activities include enhancing products and processes that already exist, you can benefit from the R&D tax credits.
  • If your business is developing a prototype or has patent applications, it is eligible for tax relief.


No matter the size of your organization, or whether you have a research lab. Your business can use R&D tax credits to lower its tax liability if it engages in any form of research or development activities. These activities include developing products and software, improving quality, employing new methods of manufacturing, etc. Many other activities qualify you for the R&D tax credits.


How can your company claim R&D tax credits?

Since there are no limits on how much you can claim as R&D costs, your company can save a lot of money through R&D tax credits. You can claim these costs for the current year or up to 3 previous years, even more, if it is a loss-making company. If there are any pending credits, they can be carried over to a previous year or the next 20 years. Combine the federal and state tax credits and you see how much money your business could save on taxes, through R&D costs alone.


To claim R&D tax credits you need to keep a record of all research activities going on in the company. Documenting transactions relating to R&D expenses is necessary to validate any research-related expenses that can be claimed for tax relief. These expenses include salaries for scientists, designers, and engineers, cost of raw materials, amounts paid to contractors, lab costs, etc.


In 2015, the Protecting American from Tax Hikes (PATH) Act made the R&D tax credits permanent. This made R&D tax credits accessible for small corporations and start-up companies. Now all companies can rely on this tax incentive to reduce their tax burden and incorporate it into their long-term tax planning strategy.


Misconceptions regarding R&D tax credits:

If you think your company does not qualify for this tax incentive, you are probably not aware of its full scope. Don’t let them hold you back.


  • Your company is not R&D-centric.

Many people think that if their business is not engaged in technology or science, they cannot claim R&D tax credits. But that is not true, a company need not have a separate research department to be engaged in any sort of research. Many companies carry out experiments or research activities in a small space or on location. These also qualify as research.


  • Employees must be scientists or have a degree in engineering.

The reason why companies that employ engineers and scientists are the main beneficiaries of the R&D tax credit is that it was introduced to encourage innovation. As engineers and scientists are considered to be innovators, it is a common misconception that your company isn’t qualified for the credit if the research isn’t conducted by them. But any research activity conducted by employees with other qualifications or by contractors is eligible for R&D tax credits.


  • Your business does not develop new products or services

The R&D tax credit is assumed to apply only to businesses that design or develop products, processes, techniques, formulations, or software. But that’s not all; if your business works on improving existing products and services or undertakes any innovation activity, it qualifies for R&D tax credits.


R&D tax credits have made it easy for businesses to devote more time and energy towards innovation and research activities. The purpose of introducing this tax credit in 1981 was to encourage companies to innovate and find creative solutions. Since then, many companies have used this incentive to their benefit. It has helped them reduce their tax liability to a great extent. Research does not only generate employment and help create new products in the market. It also makes your company eligible to claim certain tax benefits. The R&D tax credits are a well-known way of reducing a company’s tax liability. If you wish to make use of this tax credit, seek help from an attorney or a tax consultant for a proper tax planning strategy.