Many small businesses may be able to take advantage of special tax incentives by claiming qualified research expenses (QREs). Companies can not only deduct these expenses when they file taxes, but they may also be able to receive tax credits for QREs. Small businesses should take time to explore this potential opportunity and see if they are eligible. However, companies should also understand the requirements and legal implications of applying for a tax credit.
What is a Qualified Research Expense?
A qualified research expense refers to an expense that helps a company develop or improve certain products, processes, techniques or other inventions. Some expenses may include employee wages, research services, and supply expenses. Companies may claim qualified research and development expenses for any type of work that falls under this category. The research does not have to be original, and companies can also claim these expenses even if the outcome of its research is unsuccessful.
What Expenses Qualify as QREs?
Some examples of qualified research expenses can include employee wages, research expenses, and supply costs. QREs can include both in house research or contract research.
You can count employee expenses if the majority of the employee’s activity focuses on research and development, but you must demonstrate around 80% of the activities are related to the components of the four part test. If an employee only spends a third of their time on this task, then you can only claim this amount towards a tax credit.
While you can still claim expenses from non-employees, the eligible amount for contractors and external research companies is lower. You can only claim 65% of the total amount of services performed by a contractor and 75% of the amount paid to a research consortium.
Your company’s expenses need to match the four part test in order to be qualified as qualified research and development expenses. These are the four components of the four part test:
Tax Treatment of Qualified Research Expenses
If your company is investing in supplies or research services that are related to research and development, it can write off these eligible expenses on its tax return. These write offs can be a helpful way to potentially reduce your tax liability. Moreover, some small businesses may be able to receive additional benefits by claiming tax benefits.
Additionally, you should consult with a tax professional to ensure that you are taking advantage of all available credits. Consequently, this could result in significant cost savings for your company. Furthermore, it is important to keep detailed records of your R&D activities in order to support your claim.
Section 174 and QREs
Companies also need to consider Section 174 to determine if their research expenses are eligible. This is one of the most important criteria of the previous four point test mentioned in this article.
The treasury’s Section 1.174-2 states that these research and development costs must eliminate any uncertainty surrounding the development or improvement of the company’s product. Companies can qualify for the tax credit if they can prove that the research activity is qualifying, and that it can help them improve their product.
It’s crucial to note that the eligibility depends on the nature of the company’s activity, rather than specifics about the product or specific improvement in the process. Moreover, there is not a requirement that the outcome of the research needs to be successful.
Qualified Research and Development Expenses for the R&D Tax Credit: How to Maximize Your Savings
Sometimes a company may be able to claim the expense as a deduction but will not be able to receive a tax credit because it does not meet the four part test. On the other hand, some companies may be able to leverage their R&D expenditure by obtaining tax credits.
If you find that your expenses meet the four part test, you should take a look at Form 6765 and begin preparing this information in your next tax return. This form can help you calculate your qualified research expenses for R&D credit. It is ideal to keep track of all of these expenses, and even have an accountant review them before you file your taxes.
Best Practices for Qualified Research Expense Accounting
Some businesses may be unaware that they qualify for a tax credit and could be missing out on some of these potential benefits. You may be able to get up to 13 cents back on every R&D dollar spent. However, it is important to ensure your activities are eligible and to keep proper documentation of all research and development activities.
It may be best to have a tax professional complete Form 6765 for you, as this is a relatively complex form to complete. This form has detailed information, including the amount of wages paid to employees, total research expenses, and the cost of supplies.
One of the most important things you should do is keep a clear record of all of your activities. You will need to keep records of any documentation that proves that you meet the four part test. It is best to hold onto this information for multiple years in the event that you are audited.
Some of this important documentation can include payroll records, receipts from supply and equipment purchases, third party research invoices, research material, meeting notes, and other material related to research and development.
Closing Thoughts on Qualified Research Expenses
Many companies are probably already taking advantage of tax write offs for qualified research and development expenses. However, some companies may be able to further benefit by determining if these activities can help them qualify for tax credits. If you think some of your activities may meet the criteria, it may be best to talk to a tax professional to ensure that you meet the four part test. They can help you determine your qualified research expenses for R&D credit.