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How to Calculate R&D Tax Credits

POSTED 02/25/2021

As we’ve seen in the first two installments of this series, business owners often miss out on the R&D tax credit opportunity and the bottom-line infusion it can provide. Many mistakenly believe that their company isn’t eligible for the credit. Of the small percentage that do file for the credit, many fail to capture all of the qualifying expenses they’re eligible to claim. Others avoid it altogether, thinking it’s too complicated.

Part three of our R&D tax credit series gives you a look inside the calculation methods that determine the credit amount. Keep in mind that this is a high-level introduction for informational purposes only. You should always consult a qualified tax expert before you move ahead with any tax credit strategy for your business.

Let’s get started with a quick overview of R&D tax credit calculations.

There are two ways to calculate the R&D tax credit

Since the R&D tax credit was first introduced in 1981, both Republican and Democratic administrations have revised and extended it numerous times. Eligibility criteria and how the credit is applied have shifted along with changes in the tax code, but the qualification bar has tended to drift lower over the years. Businesses of all sizes may qualify.

Once you’ve decided to pursue the R&D tax credit, there are two established ways to perform the calculations:

  • The Regular Research Credit (RRC) method looks at the INCREASE in research activity and investment in a taxable year compared with a base amount
  • The Alternative Simplified Credit (ASC) method looks at the amount your Qualified Research Expenses (QRE) exceed the AVERAGE for your three previous tax years

To get specific, you calculate and report the credit on IRS form 6765 and submit it with your company’s tax return.

R&D tax credits – one size does not fit all

The calculation method that yields the maximum benefit (the best reduction in your overall tax burden) depends a lot on your individual business circumstances. Fortunately, you can change your election from year-to-year without being locked into one method if you file timely and don’t amend your return.

As noted briefly earlier, calculations are based on what the IRS calls Qualified Research Expenses, or QREs for short. Depending on conditions outlined in the corresponding IRS and Treasury codes, The tax credit rules allow you to claim various percentages of these QREs (wages, research supplies or contract research). All research and development work must be performed inside the United States. Offshore contract research is strictly ineligible.

Choosing the calculation method that’s best for your business

The important thing to remember is that tax circumstances can shift significantly along with business conditions, so it’s a good practice to carefully evaluate both options for every tax year. You may also qualify for state credits depending on the state where the research is performed.

Whichever method you choose, the resulting credit can add up to real money in business terms and have a worthwhile impact on your company’s tax position. Chances are that the eligibility bar is lower than you think, and although it does require you to get extra documentation in order, the payback from an R&D tax credit can be significant.

Contact Us

If you’re evaluating the R&D tax credit for your business, or currently claim it but are uncertain about the impact recent IRS code changes may have on your tax return, we can help you understand your options, check federal and possible state eligibility and create a strategy to maximize the benefits for multiple tax years. For additional information call us at 248.208.8860 or send us a note. We look forward to speaking with you soon.