KBKG has received a lot of frequently asked questions (faq) related to the Research and Development (R&D) Tax Credit and how it can benefit companies. Common questions and answers are outlined below:
- General R&D Tax Credits
- R&D Tax Credits for the Life Science Industry
- R&D Tax Credits for the Software Industry
- Can you amend prior year returns to claim the credit?
- Can you receive a payroll tax refund?
- How much do you charge for an R&D Study?
- How do I know if my business qualifies for this credit?
- Can depreciation ever be considered a qualified expense?
- Are R&D credits still considered to be a Tier 1 audit issue?
- Is it worth calculating the R&D credit if there's net loss and no tax due in the coming several years?
- Will this work for startup companies whose payroll is paid by a paymaster?
- Can payroll taxes include expenses paid against qualified wages?
- Are payroll taxes included in qualified wages for R&D credit purposes?
- In the previous example, why couldn't they utilize the entire tax credit?
- Would legal fees for drafting and filing patent applications qualify as "activities from concept through release to commercial production?"
- For the fixed-based percentage, does this percentage change from year-to-year, or is it a historical percentage that you use each year after your initial year of having the research credit?
- For a startup company with no sales receipt, is it true that no R&D credit is calculated because there is no fixed-based ratio?
- I thought the state of Texas has no state income tax. How can Austin claim a state-level R&D credit when there is no state income tax?
Can you amend prior year returns to claim the credit?
Yes, provided the tax year is open under statute.
Can you receive a payroll tax refund?
Yes, the payroll tax benefit is in the form of a refund.
How much do you charge for an R&D Study?
It depends on a few factors. We generally provide our clients with options both in terms of fee structure and project scope. With respect to fee structure, we normally offer our clients both a fixed fee quote as well as time and material engagements, which are capped at a percentage of the credit. Fixed fee and percentage cap amounts can vary depending on a few variables, including the nature of our involvement, the number of employees performing qualified research, the number of projects, and the scope years we look at, among other variables. If you are interested in learning more, we’d be happy to give you a high-level estimate of cost. We would just need a bit of information from you.
How do I know if my business qualifies for this credit?
R&D tax credit eligibility largely depends on whether the work you are conducting meets the criteria established by the IRS and its four-part test.
Can depreciation ever be considered a qualified expense?
Unfortunately, no.
Are R&D credits still considered to be a Tier 1 audit issue?
R&D tax credits are not a Tier 1 issue anymore.
Is it worth calculating the R&D credit if there's net loss and no tax due in the coming several years?
If the Company has W2 Wages with a related payroll expense, it is very beneficial to calculate the credit to take advantage of the payroll tax offset. Learn more about the R&D Payroll Tax Credit.
Will this work for startup companies whose payroll is paid by a paymaster?
As long as the taxpayer meets the definition of having employees, then yes. If using a PEO, then the taxpayer is eligible for the payroll credit.
Can payroll taxes include expenses paid against qualified wages?
Payroll taxes include the FICA portion of your payroll taxes.
Are payroll taxes included in qualified wages for R&D credit purposes?
Unfortunately, not.
In the previous example, why couldn't they utilize the entire tax credit?
Section 38 limits the utilization of General Business Credits (which R&D falls within).
Would legal fees for drafting and filing patent applications qualify as "activities from concept through release to commercial production?"
This is very facts and circumstances dependent. Patent application and perfection costs qualify as Section 174 R&D expenses. Some clients use this qualification to include in the R&D credit calculation. Under Section 41, guidance was issued concluding these costs are non-creditable.
For the fixed-based percentage, does this percentage change from year-to-year, or is it a historical percentage that you use each year after your initial year of having the research credit?
For companies that had R&D activities and gross receipts in 1984-1988, the fixed-based percentage is calculated and gets fixed. However, for the companies that started after, the fixed-base percentage gets fixed at the 11th year.
For a startup company with no sales receipt, is it true that no R&D credit is calculated because there is no fixed-based ratio?
Not necessarily. There are two credit calculation methodologies. Startup companies without gross receipts can use either methodology and still generate a credit.
I thought the state of Texas has no state income tax. How can Austin claim a state-level R&D credit when there is no state income tax?
Taxpayers engaged in qualified research can claim either:
- A sales and use tax exemption on the purchase, lease, rental, storage, or use of depreciable tangible personal property directly used in qualified research, or
- A franchise tax credit based on qualified research expenses.
It is important to note a taxpayer cannot claim both the sales tax exemption and the franchise tax credit for the same period.
- How much do you have to delve into the activities of outside contract service provider? Or is it mainly based on the contract and scope of work?
- Please explain how "supplies" for a manufacturing company relate to the "supplies" for a life science company,. i.e., some types of software necessary to perform our research, we consider supplies for doing our work, just like a manufacturer would purchase supplies or parts to build a product. Would you agree with this? Can you expand?
- How is the payroll tax credit received? Does the payroll company file this, or do you pay payroll taxes and then obtain a refund from the government?
- Does patent (attorney) fee qualify for R&D expense?
- Expense R&D software currently has an amortization schedule, current year R&D cost will be the amortization $ but not the entire software cost?
- You are saying to include stock compensation. Do you include stock option compensation expense? ie, not on the person's W2, but on the P&L.
How much do you have to delve into the activities of outside contract service provider? Or is it mainly based on the contract and scope of work?
This will be generally be a review of the contract and scope of work.
Please explain how "supplies" for a manufacturing company relate to the "supplies" for a life science company,. i.e., some types of software necessary to perform our research, we consider supplies for doing our work, just like a manufacturer would purchase supplies or parts to build a product. Would you agree with this? Can you expand?
Agreed. Supplies expense (not subject to capitalization) used during the development process are includable in the R&D credit calculation (ex: test tubes, testing papers, beakers, organisms, pH supplies, etc.).
How is the payroll tax credit received? Does the payroll company file this, or do you pay payroll taxes and then obtain a refund from the government?
This will be dependent on the payroll company. Generally, the easiest way to monetize the credit is to file for a refund of the qualified portion payroll taxes paid in the previous quarter.
Does patent (attorney) fee qualify for R&D expense?
Patent perfection and patent application fees do qualify as R&D expenses from a Section 174 perspective. However, the government distributed guidance disallowing these expenses as includable for R&D credit purposes.
Expense R&D software currently has an amortization schedule, current year R&D cost will be the amortization $ but not the entire software cost?
If the software is purchased off the shelf and is amortized, the expense would not be includable.
You are saying to include stock compensation. Do you include stock option compensation expense? ie, not on the person's W2, but on the P&L.
No, only wages subject to withholding are potentially includable as qualified research expenses.
Does the taxpayer (software company) need to be paying taxes to qualify for the R&D Credit? Will a non-taxpaying (software) C or S corporation qualify?
No. There is no requirement for a taxpayer to be tax-paying to be eligible for the research credit.
What about a corporation that has gross receipts composed of both grant proceeds and software sales? Are they eligible?
A taxpayer with gross receipts comprised of both grant proceeds and software sales may still be eligible to claim the research credit.
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