Business owners can use the federal R&D tax credit to reduce their tax burden and keep money in their pockets.

Creative companies that don’t apply for a federal R&D tax credit are losing money. An R&D tax credit is a reward bestowed by the federal government to companies that engage in R&D activities. Since these activities create jobs and fuel the economy, the government wants to incentivize companies to keep creating and innovating new products. Keep reading to learn how why you should apply for an R&D tax credit and reduce your tax burden.

What are the Benefits of an R&D Tax Credit?

No matter what new product you’re developing, innovation can be expensive. That’s why there are R&D tax credits for breweries, beauty manufacturers, and more. The federal R&D tax credit program rewards you for the time and money you’ve spent on creating a new product. Through this program, you could get back 7-10% of your qualified research expenditures (QRE) as a tax credit. Your QRE include:

  1. Part and full-time salaries of  R&D focused employees
  2. Cost of disposable supplies for R&D
  3. 65% of R&D contractor fees

Bear in mind that your W2 employees and hired contractors must be based in the U.S. Totaling these three items will allow you to estimate how much your credit  could be.

For example, let’s say that your R&D employees’ salaries came out $300,000, and you spent $25,000 on disposable supplies for R&D. You also hired a contractor for $60,000. Enter those figures into an R&D tax credit calculator, and you’ll see that your credit could be as much as $36400.00. That credit can then, depending upon certain circumstances, be used against the social security portion of your payroll tax or your business income tax.

What is Social Security Tax?

Employers and employees have to contribute to the social security tax, which is a federal tax that funds social security benefits. You may see these payroll taxes labeled as FICA (Federal Insurance Contributions Act), but if you’re self-employed this is often called “self-employment tax.” The IRS reports that social security makes up 6.2% of your business’ total payroll tax as employers and employees split this burden, but self-employed individuals pay 12.4%. How much you pay into this will depend upon your employees’ salaries.

Social Security Cost

Employers only need to withhold social security tax on the first $160,200 an employee makes per year. You can find out how much you need to withhold for taxes by multiplying an employee’s gross monthly income by 6.2%. Below, you can observe how much to withhold for social security if an employee makes $3,000 per month:

$3,000 x 0.062 = $186

Following this scenario to its conclusion, $186 would be withheld from the employee’s paycheck, and you would contribute an additional $186 to the employee’s Social Security.

But what do you do if your employee makes over $160,200 per year? If your employee makes $190,000, you will still withhold 6.2% of that individual’s pay on the first $160,200, or the first $13,350 of every month. Using the same formula shown above, you’ll find that the monthly withholding for social security is $827.70. As you can see, the social security portion of your payroll tax can be quite expensive when you have multiple employees. This is why the federal R&D tax credit is so beneficial to companies that are no more than five years old and are pre-revenue or making less than $5 million.

This credit can be used, dollar-for-dollar, to reduce a company’s social security tax burden and keep more money in the bank. Companies outside these parameters though will have to use the credit to reduce business income tax expenses.

What is an Income Tax Expense?

Levied by the government, the income tax expense is directly focused on a business’ taxable income. You can determine your business’s income tax expense by identifying all of your taxable income and determining your business’ tax rate. Then, you can use your R&D tax credit to offset your income tax burden. Companies that are making more and less than $5 million also have the option to carry the federal R&D tax credit forward by 20 years. The flexibility of this tax credit makes it a truly invaluable asset that can keep your money secure and ready to fund new innovations.

Is the Federal R&D Tax Credit Refundable?

The federal R&D tax credit isn’t refundable. Unlike other tax credits that you can cash, this is a true tax credit that can only be applied against a business’ payroll or income tax expenses. There some state tax credits, like Pennsylvania’s R&D state tax credit, that do allow businesses to sell them for a profit.

How Do I Claim My Federal R&D Credit?

Claiming a federal R&D tax credit is an incredibly important step for innovative companies. When considering an R&D tax credit, you need to first identify if your business qualifies. See if you can positively answer these five questions:

  1. Developed a new product or process or improved upon existing functionality?
  2. Dealt with some form of uncertainty in the development process (appropriateness of design, method used, etc.)?
  3. Utilized a process of experimentation to eliminate uncertainty (modeling, prototyping, trial and error or other testing)?
  4. Conducted experimentation which relied on engineering, biological, physical or computer science?
  5. Employed all or a portion of your workers within the United States?

If you were able to pass this short quiz, you could qualify for a federal R&D tax credit. After confirming your business’ eligibility, you can move on to determining your QRE. The process of applying for a tax credit involves multiple steps, so it’s best practice to work with an R&D tax credit professional. That way, you can be sure that you’re maximizing your credit. A full-bodied R&D tax credit application is also known as an R&D tax credit study. These studies serve as a defense if your business were ever to face an IRS audit.

In Review: Why You Should Apply for an R&D Tax Credit

A federal R&D tax credit is an incredible asset to innovative companies. With this credit, you can receive as much as 10% of your QRE back as a credit and directly reduce your payroll or income tax burden, depending upon your business’ circumstances. Qualifying companies that fail to apply for this credit will have to pay for these taxes out of pocket.

Since it’s imperative to properly complete your R&D study, work with an R&D tax credit professional to get the best possible result. Call Bowers R&D at 610-368-5877 today to get the credit you deserve.

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