Tax season is the timeframe when individuals and businesses in Los Angeles, or other metro cities file their income taxes. Tax prep can be a time-consuming process for businesses because they are inclined to follow U.S. tax codes, and failure to comply may result in stiff penalties. Whether you are the owner of a smaller or larger company, you may be eligible to claim tax credits. They reduce the amount of income tax your business owes to the state and federal governments. As the tax deadline approaches, companies may be eligible for the Research and Development Tax Credits.
What is the Research and Development Tax Credit, and How Does It Help Businesses?Founded in 1981, the federal Research and Develop (R&D) Tax credit is a two-year incentive that offers an offset for the federal and state income tax liability. It is available in over 30 states, and its purpose is to reward companies for increased investments in their current tax year. This tax credit is available to companies that develop new or improved business elements such as products, processes, computer software, and techniques that improved quality, reliability, functionality, and performance. Although the Tax Cuts and Job Act (TCJA) in 2017 paved the way for businesses, the R&D Tax credit has provided opportunities that limit tax liabilities that have helped companies save thousands of dollars.
How Can Your Organization Benefit From the R&D Tax Credit?Companies can benefit from the R&D Tax credit because it is a dollar-for-dollar credit that reduces a company’s tax liability. There is no limit on the amount of credit that can be claimed per year, however, if the credit cannot be used immediately, it will be carried over depending on the state’s carryover regulations.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently expanded the R&D Tax credit. The purpose of this expansion was to create a tax benefit for start-ups and small businesses. After December 31, 2015, smaller businesses were allowed to utilize the R&D tax credit against their alternative minimum tax (AMT) restrictions. Furthermore, the PATH Act allowed startup businesses to use the tax credit if they did not have federal tax liabilities or gross receipts of less than $5 million. It gave smaller companies in Los Angeles, or other metro cities a refundable credit limit of $250,000 for up to five years.
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How Can My Company Qualify for the Tax Credit?Many companies believe this tax credit only applies to product development purposes. Moreover, eligibility for startups can apply this tax credit for up to five years. Your organization may qualify if it:
To qualify, a company must meet the criteria in a four-part test.
Some activities do not meet the criteria in the four-part test. Some activities include:
Other activities that do not qualify are:
Your company located in Los Angeles, or other metro cities does not have to employ scientists to qualify for the R&D tax credit. Architecture, engineering design firms, and software development companies also qualify.
How Can My Company Claim the R&D Tax Credit?A company can claim the R&D tax credits by filing an IRS Form 6765, Credit for Increasing Research Activities. During the process, they need to identify qualifying expenses and provide documentation that states how these costs meet the requirements. As previously mentioned, R&D tax credits develop an offset towards income tax liability. Companies can take advantage of the credit by looking over their previous tax years. If a business does not have a current taxable income or has a limit on tax credit, the federal credit can be carried forward for up to 20 years.
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How Do Companies Fill Out Form 6765?Businesses must complete four sections:
To claim the R&D tax credit, companies must document an estimate of expenses from qualified research. Examples of documentation include:
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What Expenses Qualify for the R&D Tax Credit?Expenses include:
Any sized U.S. companies in Los Angeles, or other metro cities from any industry can benefit from the R&D tax credit if they pay or are expected to pay:
Here are a few ways the R&D tax credit can benefit your business:
The RRC is a credit that is 20% of a company’s current yearly qualified research expenses (QRE) over the base amount. To calculate the credit, a business needs the average annual R&D receipts over the previous four tax years and if the business was established before 1980.
What is the Alternative Simplified Research Credit (ASC), and How is it Calculated?The ASC is one of four tax credits that make up the research tax credit. Unlike the RRC, it does not require annual gross receipts. This method allows companies to claim the R&D credit if they lack prior company records to document their base amount. Companies that are not eligible under the regular tax credit might qualify for the R&D tax credit.
As of 2009, the ASC is equal to 14% of QREs earned in the current tax year, and over 50% of the average QREs in the last three years. If a taxpayer did not have QREs over the last three years, the credit is 6% of the QREs in the current tax year. Here is the four-step calculation process:
Businesses may not qualify for the RRC credit if they experienced a decline in R&D spending. They can still qualify for the ASC credit. For instance, if the R&D credit becomes more efficient with lesser costs, it could have a negative impact on R&D spending. A business in Los Angeles, or other metro city may not meet the requirements in the base period, making it ineligible for credits under the regular tax method.
How Do the ASC and RRC Calculations Compare?Unlike the ASC, the RRC tax credit may result in a larger credit in some cases if the base amount is low. Other circumstances for using this method occur when a business is a startup or if the R&D spending is recent. The RRC method is more complex because it requires a great deal of time and effort to gather data.
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