Even with this stability, however, there are common factors that companies assume prevent them from claiming the credit.
1. The Organization Isn’t Paying Federal Income Tax
Start-up companies and small businesses may be eligible to apply up to $1.25 million—or $250,000 each year for up to five years—of the federal R&D credit to offset the Federal Insurance Contributions Act (FICA) portion of their payroll taxes each year.
To be eligible, a company must meet two requirements:
- Have less than $5 million in gross receipts for the credit year
- Have no gross receipts or interest income dating back more than five years
The R&D credit is calculated on the federal income tax return as usual and may be applied against payroll taxes starting the quarter after the credit is elected. For calendar-year taxpayers, the R&D credit can be applied against payroll taxes as early as April of the following year.
2. The Company Isn’t Focused on R&D
It’s not only high-tech or life sciences companies with dedicated research departments that qualify for the R&D tax credit. Indeed, most companies don’t have R&D laboratories and instead perform R&D in their test kitchens or fields, wineries or distilleries, or on production floors. Wherever experimentation occurs, R&D may be found.
Our R&D Tax Services page contains examples of qualifying activities across industries.
3. Employees Aren’t Degree-Holding Engineers or Scientists
Companies with large numbers of engineers and scientists stand out as prime candidates for the R&D tax credit because the credit was created to encourage research and experimentation based on the hard sciences.
This holds true regardless of who performs the activities and can include employees with many different job titles and backgrounds. Experimentation performed by both employees and third-party contractors who engage in the improvement of projects and processes may be included.
4. The Company Isn’t Developing Anything New
The R&D tax credit is for taxpayers that design, develop, or improve products, processes, techniques, formulas, or software. It’s calculated on the basis of increases in research activities and expenditures—and as a result, it’s intended to reward companies that pursue innovation with increasing investment.
R&D doesn't have to be new to the industry. It simply needs to be new to the company, which must have activities that meet the four-part test below.
5. The Company Is Subject to Alternative Minimum Tax (AMT)
Historically, many companies performing R&D haven’t benefited fully from the credit because the company—or its shareholders, in the case of pass-through entities—were subject to the alternative minimum tax (AMT).
For tax years beginning on or after January 1, 2016, individuals or eligible small businesses (ESBs) who are subject to AMT can offset regular taxes and AMT using the R&D tax credit. ESBs are nonpublicly traded companies with average revenue of $50 million or less over the previous three years.
This means R&D credits that may have been previously unusable for ESBs can now be applied to reduce AMT.