Research & Development Credit
The research and development (R&D) credit is a federal tax credit available to U.S. companies for increasing research activities. The research must be undertaken for discovering information that is technological in nature, and its application must be intended for use in developing a new or improved business component of the taxpayer. In addition, substantially all of the activities of the research must be elements of a process of experimentation relating to a new or improved function, performance, reliability, or quality.
What Expenses Qualify?
- Wages paid to employees for qualified services
- Supplies (defined as any tangible property other than land or improvements to land, and property subject to depreciation) used and consumed in the R&D process
- Rental or lease costs of computers
- Contract research expenses paid to a third party for performing research activities in the United States on behalf of the taxpayer.
Payroll Tax Offset
Qualifying small businesses can make an annual election to apply the R&D credit to its social security portion of employer payroll taxes. A qualified small business is a corporation (including an S corporation) or partnership with gross receipts of less than $5 million for the tax year, and no gross receipts for any tax year before the 5-tax-year period ending with the tax year. The election is available for the first five years the business has gross receipts and the maximum amount of credit that can be applied to payroll taxes is $250,000.
A qualified small business that elects to claim the payroll tax credit will claim the payroll tax credit against the employer’s portion of social security tax on its employment tax return for the first quarter that begins after it files the return reflecting the payroll tax election. A qualified small business claiming the payroll tax credit on its employment tax return must complete Form 8974 and attach the completed form to the employment tax return.
Paycheck Protection Program and Employee Retention Credit Impact
Many businesses that suffered economically from the pandemic benefited from Paycheck Protection Program loans (PPP) and Employee Retention Credits (ERC). The Consolidated Appropriations Act (CAA) addressed the impact of these programs when identifying qualified research expenses. The R&D tax credit requires that expenditures be deductible to qualify for the credit and the CAA confirmed that business expenses paid out of forgiven PPP loans are deductible for federal income taxes purposes. Therefore R&D expenses paid with PPP loan funds are eligible for the R&D tax credit. Additionally, the CAA clarified that wages taken into account in determining a taxpayer’s 2021 ERC may NOT be considered in determining the R&D tax credit. Businesses that are eligible for the ERC and R&D tax credits should analyze their eligible expenses for purposes of maximizing both credits.
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By Brittany Burke and Chris Hart, CPA