If you are trying to lower your tax burden, the Research and Development (R&D) tax credit can help. This popular employer tax credit can reduce your payroll tax burden. Even if you don’t need the payroll credit this year, you can carry it forward for up to 20 years. 

What Is an R&D Credit?

The goal of an R&D credit is to encourage research and development activities in the United States. Unfortunately, many small businesses aren’t taking advantage of these credits. Consider the following statistics. 

• There are 14,673 R&D credits claimed each year in the United States. 
• The biggest 0.13% of companies in the nation claim 14% of the R&D credits. 
• Small businesses make up 24.55% of the country’s companies, but they only claim 15% of credits.

This is particularly unfortunate because the R&D credit uses an incredibly broad definition of what R&D is, so many small businesses are likely eligible for it. However, small businesses aren’t always aware it exists. As Shannon Scott, CEO of HR Logic, mentioned in his recent Mission to Grow podcast interview, “I always like to say the IRS doesn’t hold classes on how to avoid paying taxes, right?”

In Scott’s experience, many companies are eligible for R&D credits. Because the federal government wants to encourage R&D, audits rarely happen with this type of credit unless there is outright fraud involved. 

Who Is Eligible for R&D Credits? 

A wide variety of companies are eligible for R&D credits. You can claim this credit if you make a new product, improve a production process, increase automation in manufacturing, or refine your current techniques. 

With R&D credits, there is a four-part test you can use to determine if you are eligible to take this credit. 

Section 174 Test: Do your expenditures directly relate to your trade and industry? 

Business Component Test: Is it possible to apply the developments or discoveries as a new or improved component of your current business?   

Technological Information Test: Do you use experimentation methods that are based on the hard sciences, like engineering, biology, or computer science? 

Experimentation Test: Are you assessing different designs and processes where you don’t already know the outcome?

While it sounds highly technical, there are a wide variety of R&D programs that qualify. For instance, even a chef experimenting and making different recipes counts as an R&D credit. 

For tax years starting after December 31, 2022, the maximum R&D credit you can apply is $500,000. Previously, the maximum was $250,000.

Can Small Businesses Get R&D Credits? 

Small businesses are absolutely eligible for R&D credits. This law was intended to help companies of any size pursue research and development projects. Unfortunately, only a tiny percentage of small businesses have taken advantage of the R&D credits they’re eligible for.   

You don’t even have to be incorporated as a standard corporation. The R&D credit is available for other business types, such as S corporations. Because of this, it’s important to talk to a tax or HR consultant about applying for this credit.

 

5 Advantages of Getting the R&D Credit 

If you’ve recently invested in research and development at your company, you may be able to use your investment to get a lower tax bill. Through the R&D credit, you can enjoy a few distinct advantages.

1. Reduce Your Federal Tax Liability

R&D credits can reduce your payroll tax liability. It specifically targets the old age, survivors, and disability insurance (OASDI) tax, which is currently at 6.2% for employers. By claiming the R&D credit, you can avoid paying this cost.

2. Carry Credits Forward for up to 20 Years

This credit is a carryforward, so it allows you to enjoy tax savings for up to 20 years. If you’re a startup with few employees and a large research budget, this is a great credit to use.

3. Many Activities Qualify

Best of all, many different activities can qualify as research and development. While most people think of a scientist in a laboratory when they hear someone mention research and development, R&D credits cover many types of research. From researching recipes to trying out a new product design for your clothing company, R&D credits cover a surprising variety of activities.

4. Lower R&D Costs by Around 10%

Your actual savings can vary based on many factors. For instance, many states offer R&D credits that you can use alongside national credits. However, most companies will get about 13 cents out of every dollar they spend on R&D back. 

5. Increase the Amount of Money You Can Invest in Growth

The entire purpose behind R&D credits is to encourage companies to make investments in new technology. By reducing the cost of your research today, R&D credits give you more capital for future research and development projects.

 

Learn How to Get R&D Credits for Your Company

While small businesses are eligible for R&D credits, many business owners are unaware of these credits and how to apply for them. By figuring out how to calculate your R&D credits, you can save a significant amount of money on your payroll taxes. 

If finding employer tax credits is challenging, we can help. To learn more about R&D credits and other ways to reduce your payroll taxes, reach out to our small business HR & payroll experts today.