R & D Tax Credit

I spun around without a care

When I stopped, I felt lost

I’m two heels from the top tier

Really want to be boss

I figured it out, figured it out somewhere

Maybe the answer’s not out there

Maybe it’s on the ground somewhere

When I stopped, I felt lost

Do you ever feel lost?

-Moving Backwards, A Tribe Called Quest (chorus: Anderson .Paak)

I know that small business owners get frustrated with their business progress. There are times that things seem to be moving backward. What if I told you that there is a tax credit that can help your business move forward? In this article, I will talk about how blockchain companies can take advantage of Research & Development (R & D) tax credit. As with all things tax-related, this tax credit is not simple. The R&D Tax Credit has been around since 1981, it has expired eight times, it’s been extended fifteen times, The Protecting Americans from Tax Hikes (PATH) Act of 2015 finally made the R&D credit permanent and expanded its application to create a potential tax benefit for small businesses and start-up companies. Any company that encounters and resolves technological challenges may be eligible for the R&D tax credit. A company does not need to be profitable to claim the credit. Because of the permanency of the R&D credit, blockchain companies can now rely on and incorporate it into their annual tax-planning strategy.

Under the R & D tax credit, 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. However, for amounts paid or incurred in a tax year beginning after December 31, 2021, the law will require taxpayers to capitalize and amortize IRC Section 174 research and experimental (R&E) expenditures over a five year period, beginning with the midpoint of the taxable year in which the expenditure is paid or incurred. Costs for research conducted outside of the U.S. will be amortized over a 15-year period.

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 claimed. If a company doesn’t currently have taxable income or is otherwise limited in how much tax credit it can use, the federal tax credit can be carried forward for 20 years or potentially applied to offset the company’s federal payroll tax under the newly expanded rules. You can go back now as far as the statute of limitations are open which is three years from the filing date on the federal tax returns. Keep in mind that you can also go back now and amend these prior to your tax returns and roll these tax credits forward if they’re unused.

To be eligible, a company must meet two requirements:

1. Have less than $5 million in gross receipts for the credit year

2. Have no more than five years of gross receipts

Four-Part Test

1. Elimination of uncertainty. A company must demonstrate it has attempted to eliminate uncertainty about the development or improvement of a product or process.

2. Process of experimentation. A company must demonstrate — through modeling, simulation, systematic trial, and error, or other methods — that it has evaluated alternatives for achieving the desired result.

3. Technological in nature. The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology, or computer science.

4. Qualified purpose. The purpose of the research must be to create a new or improved product or process, resulting in increased performance, function, reliability, or quality.

Qualified expenses fall under three categories:

1. Wages: Amounts paid to employees that are directly involved in the research or supervising and supporting the research.

2. Supplies and materials: any supplies or materials that are used or consumed during the R&D process. This can refer to a manufacturing facility where a company is testing these supplies that may not be used after commercial release. The cost of cloud storage can qualify.

3. Contract research

Depreciable items, like hardware, are not a qualified expense.

Documentation

To claim this credit, qualified companies must evaluate and document their research activities contemporaneously to establish the number of qualified research expenses paid for each qualified research activity. While companies may estimate some research expenses, they must have a factual basis for the assumptions used to create the estimates.

Examples of contemporaneous documentation include these items:

• Payroll records

• General ledger expense detail

• Project lists

• Project notes

• Lab results

• Emails and other documents a company produces throughout the regular course of business

As always, make sure to have a conversation with a tax accountant to see if your company qualifies.

R & D Tax Credit

Want tax & accounting tips and insights?