4 Common R&D Tax Credit Myths Debunked

Authors: Chelsea Smith, Tax Partner & Sandra Bullock, Tax Supervisor

What are some of the most common Research & Development (R&D) Tax Credit myths?

Misconceptions about the R&D Tax Credit can cause businesses to overlook activities that may qualify. Eligibility is based on qualifying activities, not simply a company’s industry, size or the success of a project.

Here are four common R&D Tax Credit myths and what businesses should know.

Myth #1: You Have to Be a Technology Company to Qualify

One of the biggest misconceptions about the R&D Tax Credit is that it’s primarily for technology companies, scientists or people working in labs. In reality, the R&D Tax Credit is based on activities, not industries.

Businesses may have qualifying activities when they’re developing or improving a product, process, technique, formula or software and those activities meet the applicable requirements.

That means R&D can occur across a wide range of industries, including manufacturing, construction, engineering, food and beverage, software and medical products.

Many businesses are already performing potential R&D activities. They simply haven’t looked at those activities through the lens of the tax credit.

Myth #2: Your R&D Project Has to Be Successful

It doesn’t. In fact, unsuccessful projects and failed testing can help demonstrate an important element of qualifying R&D: uncertainty and a process of experimentation.

Research and development inherently involves trying different approaches without knowing exactly what the outcome will be. A business may invest time and resources into testing a new process, design or product only to determine that the approach doesn’t work.

The lack of a successful outcome doesn’t necessarily disqualify the underlying R&D activities. What matters is the process the business went through and whether those activities meet the applicable requirements.

Myth #3: You Have to Invent Something Completely New

An innovation doesn’t have to be new to the world or even new to your industry to potentially qualify for the R&D Tax Credit. The focus is on what is new or improved within your own business.

For example, a company might redesign part of an existing manufacturing process, improve the functionality of a product or develop a new approach to an internal process.

The key is understanding what uncertainty existed, what the business was trying to improve and how it experimented with different approaches to reach the desired outcome.

Myth #4: The R&D Tax Credit Is Only for Large or Profitable Companies

The R&D Tax Credit isn’t reserved for large companies.

Businesses of different sizes may benefit from the credit, and the financial impact can be particularly meaningful for smaller companies and their owners.

Certain qualifying startups may also be able to use the R&D Tax Credit against payroll taxes rather than income taxes if they meet additional requirements. This can make the credit relevant even for an early-stage company that does not yet have income tax liability.

The size of the business isn’t the determining factor. The better question is whether the company is performing qualifying activities and has expenses associated with those activities. From early-stage startups to established companies, the R&D Tax Credit can provide meaningful value when the activities and requirements align.

How to Claim the R&D Tax Credit: Form 6765

Businesses claim the R&D tax credit by completing IRS Form 6765, Credit for Increasing Research Activities, and filing it with their tax return. Here is the general process:

1. Identify potential R&D activities by reviewing projects that involved developing or improving a product, process, technique, formula or software.
2. Then, apply the qualification criteria. Test each project against the four-part test.
3. Gather qualified research expenses, such as wages, supplies and contract research costs associated with each qualifying project.
4. Remember to document the work, recording everything from failed project to the alternatives tested, revisions and the people and costs involved.
5. Choose a calculation method. Compare the regular credit and the alternative simplified credit to see which fits your situation.
6. Complete Form 6765 and file. Attach the form to your return. Eligible startups electing to apply the credit against payroll taxes also complete a separate payroll tax credit form.

Because documentation and calculation choices affect the outcome, many businesses work with a tax advisor before filing.

How Can Squire Help?

Have questions about your R&D Tax Credit eligibility or how to prepare a defensible claim? Contact us at info@squire.com to connect with our R&D Tax Credit team.

About Squire

Squire is an audit, tax, and business advisory firm with offices and teams across the Mountain West. With 50+ years of experience, we provide outsourced CFO and controller support, bookkeeping, payroll, sales tax, transaction support, ERP implementation and technology integration, helping businesses operate efficiently, stay compliant and achieve their financial goals. For more information, visit www.squire.com.

The information contained in this article is provided for general informational purposes only and is not intended to constitute accounting, tax, legal, investment, or other professional advice. The information may not be applicable to your specific circumstances. You should consult with a qualified professional before taking any action or making any decision based on this information.