R&D Tax Credits for Small Businesses

Did you know that businesses that engage in research and certain manufacturing processes may be eligible for a tax credit? The Research and Development tax credit, or R&D credit, may be able to reduce your small business’s tax burden and allow you to obtain funding for further research. To access this funding and reduce your company’s tax burden, you will need to complete IRS Form 6765.

What Is Form 6765?

Does your company specialize in creating new products, research, or developing existing products? If so, you may be eligible for special tax benefits. The R&D tax credit allows companies that engage in research and development activities to offset their business’s tax liability. It is meant to encourage companies to innovate, create, and perform research that will be useful to society.

To qualify for this credit, you will need to complete and submit Form 6765 and submit it to the Internal Revenue Service on time for this tax year.

How To Fill Out Form 6765

Part of the 1120 package, also known as the Annual Income Tax Return, Form 6765 must be completed if you want to claim the R&D tax credit. Form 6765 comes with Form 3800, which is known as the General Business Credit, which is accompanied by Form 8974, the Qualified Small Business Payroll Tax Credit for Increasing Research Activities. Form 8974 must be filed quarterly once you complete the 1120 package.

Form 6765 should be filed by April 15th of each year. If your form is approved by the IRS, you could collect up to $250,000 in funding and receive the cash-back payroll tax credit. If you extend the 1120 package, you will need to file by October 15th of each year. You may file 6765 even if your company is not profitable or generating revenue at the time.

To properly document your R&D qualified expenses, you must complete the four primary sections of the R&D payroll tax credit form:

  • Section A has eight lines of required information and is used to claim the regular tax credit.
  • Section B only applies to the ASC (Alternative Simplified Credit).
  • Section C identifies additional schedules and forms that need reporting based on the structure of your business.
  • Section D only needs completion if your qualified small business makes a payroll tax election.

The IRS strongly recommends small businesses calculate their tax credit using both the simplified and regular credit methods before completing sections A or B. This will allow eligible companies to obtain the greatest small business payroll credit.

How Does Form 6765 Tie to the R & D Tax Credit?

You must complete and submit Form 6765 to claim your eligible small business research credit. Generally, 6-8% of a business’s qualifying expenses can be applied against its federal income tax liability (dollar for dollar). If your business engages in any of the following activities, you should complete Form 6765:

  • Develops intellectual property
  • Develops patents, processes, techniques, formulas, software, or prototypes
  • Pays a specific amount for salaries, contract research, cloud hosting, or supplies
  • Redesigns or improves existing products
  • Commits resources and time to creating, developing, or manufacturing innovative products
  • Hires engineers, scientists, or designers who engage in qualified activities

You will need to compile all your important receipts to accurately fill out Form 6765. If you have less than $5 million in receipts for the present year and have not generated gross receipts for less than five years, you may still be eligible for a tax credit. A newer R&D credit-eligible small business may be able to offset payroll taxes for up to five years.

How To File Form 6765

There are a couple of different ways to file the form. You have the option to complete the form on your own, but there is the risk of making a serious mistake that can jeopardize your tax credit.
If you have tax software, you can use it to file. However, hiring a tax professional to file on your behalf is often the best choice. A tax professional will have experience completing Form 6765 and know how to avoid common filing errors.

Once you or your professional submit Form 6765, the IRS will process it and let you know if you are eligible for the tax credit.

The Payroll Tax Offset

The R&D tax credit allows eligible businesses to offset the credit against their payroll taxes. This means that in addition to reducing their income tax liability, companies can utilize the credit to offset a portion of their payroll tax obligations. The R&D tax credit can provide substantial relief by reducing the burden of employment taxes, freeing up capital that can be reinvested into further innovation and growth.

Requirements and Benefits

Businesses must meet specific criteria to qualify for the R&D tax credit payroll tax offset. Generally, eligible research activities must meet the criteria of being technological, involving the elimination of uncertainty, and aiming to develop new or improved products, processes, or software. It’s crucial to consult with tax professionals or specialists to ensure compliance with the R&D payroll tax credit requirements specific to your jurisdiction.

The Impact of the R&D Tax Credit on Payroll Taxes

The R&D tax credit payroll tax offset offers a unique advantage allowing businesses to derive immediate benefits. By reducing payroll tax liabilities, companies can allocate more resources towards research and development initiatives, fostering innovation and accelerating growth. This synergy between the R&D tax credit and payroll taxes creates a win-win situation for businesses, as they can simultaneously invest in their workforce and drive technological advancements.

The R&D tax credit provides an invaluable opportunity for businesses to enhance their innovative capabilities while reducing their tax burdens. Leveraging the payroll tax offset feature of the R&D tax credit can yield substantial benefits, enabling companies to allocate resources strategically and fuel growth. As R&D continues to be a driving force behind success, businesses should explore the potential of the R&D tax credit and consult professionals to ensure compliance and maximize its advantages. Embrace innovation, unlock savings, and propel your business forward with the R&D tax credit and its payroll tax offset provisions.

What About Section 174?

Many small and large businesses rely on research and development to improve their offerings, compete with international markets, and increase profits. The implications of recent changes to section 174 and no movement from Congress have left many business owners trying to figure out how to move forward with R&E expenses for the 2022 tax year and beyond and how to qualify for the credit and manage their qualified research expenses.

However, the Tax Cuts and Jobs Act of 2017 changed Section 174, which went into effect for tax years beginning after December 31, 2021. Under the TCJA, businesses must capitalize and amortize R&D costs over a five-year period for domestic costs and a 15-year period for foreign costs. For instance, software development expenses are now included under the umbrella of Section 174 and must be capitalized and amortized, further impacting the qualification for the credit and management of qualified research expenses.

What Is the Interaction Between Section 174 and the R&D Tax Credit Under Section 41?

The IRS section 41 research credit is a permanent tax incentive for qualified research activities, which can be determined using the four-part test for R&D qualification:

  • Permitted Process: The research activity must be directly tied to developing a new or improved business component for a permitted purpose (functionality, quality, performance and/or reliability). Notably, the business does not have to be successful in improving the component to earn the credit.
  • Technological in Nature: The activities performed must fundamentally rely on hard sciences. For example, the activities should be grounded in biology, computer science, physics, engineering, chemistry, geology, or a similar field.
  • Eliminate Uncertainty: At the outset, the taxpayer should have uncertainty around either the appropriate design, method, or capability to achieve the intended results. For example, the taxpayer could not know whether a product is feasible, if the design is technically sound, or how the result can be achieved.
  • Process of Experimentation: Businesses must experiment and evaluate alternatives through a process of modeling, testing, simulating, and systematic trial and error.  

While both IRS section 174 and section 41 deal with incentives to encourage research and development, section 174 covers a wider range of expenses. However, the costs claimed under section 41 must also meet section 174 requirements. Additionally, section 41 qualified research does not include activities that involve:

  • Surveys, advertising, or market research
  • Duplication or adaptation of an existing business component
  • Research conducted outside of the U.S.
  • Research in the arts, humanities, or soft sciences
  • Funded research from a grant, government, or other outside entities

The changes listed in TJCA did not have a material impact on the section 41 credit. However, the proposed American Innovation and Jobs Act would expand this section as it pertains to qualified small businesses. As noted in section 41(h), qualified small businesses can currently utilize the R&D credit to offset payroll tax. Some of the suggested amendments include doubling the cap from $250,000 to $500,000, allowing startups to claim the refundable credit for up to eight years instead of five, expanding the startup credit rate to 20%, and increasing the gross receipts threshold to $15M.

Learn More About the Research & Development Tax Credit

If your company needs to file the small business research and development tax credit form, KBKG can assist. Our company has extensive experience helping small businesses obtain the R & D tax credit, and we are confident we can guide you through the filing process. We are up to date on all new R&D tax credit legislation and can consult on your R&D credit small business-related questions. Contact us today to learn more.