Are you equipped to advise your clients on how to claim R&D tax credits? 

Now is a crucial time to get your clients as many tax breaks as possible, but many factors affect your clients’ eligibility for R&D tax credits.

This article addresses and answers frequently asked questions about R&D tax credits. 

Some questions that you need to know about R&D credits, including: 

  • What entities can claim R&D tax credits?
  • How far can you carry forward and carryback R&D tax credits?
  • Can a business claim an R&D tax credit based on internal-use software? 

As an accountant, it’s important that you know the answers to these questions so that you can help your clients through the process of claiming an R&D tax credit.

“What is an R&D tax credit?”

A Research and Development tax credit is a federal tax credit that businesses can apply for that’s worth up to $250,000 per fiscal year. Although many view the credit as applying to companies in the fields of science and technology, many businesses are eligible for claiming an R&D tax credit. 

While it’s commonly believed that only larger businesses or tech companies can apply for the credit, that actually isn’t the case. In fact, in 2018, Gusto helped over 1,000 clients claim 32 and a half million dollars in funds and even helped one of its accountant partners build a $250k line of business for R&D tax credits. If your client’s business uses research and testing to develop new products, they may qualify for an R&D tax credit. Here at Gusto, we help your clients easily claim and use R&D tax credits to offset payroll and income taxes. When you sign up for Gusto Pro, you gain access our R&D tax credit services as well as many invaluable resources for your clients, such as payroll, benefits, and HR.

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“What types of entities can claim an R&D tax credit?”

All entities can claim an R&D tax credit except for non-profit organizations. Corporations, individuals, and pass-through entities can all claim R&D tax credits. 

If we are looking at a payroll credit, the payroll credit would actually stay with the business entity and be used against the business entity’s payroll tax liability. As an income tax credit, it does actually flow to the owners of the business. So the partners or the shareholders in an S-corporation, the credit is claimed with the business income tax return, and then it comes through to the individual owners.

If a business uses an R&D tax credit to offset its payroll taxes, the credit stays with the business itself, but if it’s used to offset income tax, the owners receive the credit.

“How do the tax credit carryforward and carryback periods work?”

Carrying your clients’ tax credits forward and back is a great way to save them money. The rules for carryforwards and carrybacks have evolved over the years. What we’re looking at is income tax credit, which is a little bit confusing because the rules have changed recently. Right now where we currently stand, we have the ability to offset tax liabilities for not only the current tax year but also going forward up to 20 years as well as the carryback period.

When claiming an R&D tax credit for income taxes, your client has the flexibility of offsetting tax liabilities forward 20 years or back one year.

“Can an entity switch between using their credit from a lookback income credit to payroll credit?”

Your clients can only use R&D tax credits for their income taxes on a lookback. This is because you can’t apply for a payroll credit on an amended return. 

Although they can’t claim a payroll credit on an amended return, your client can apply a payroll tax credit for the current year and then claim income tax credits on previous returns.

One important thing to note about the payroll credit is that it’s limited to the first five-year period that the company has gross receipts. Even if your client doesn’t have gross receipts for years, they’re still limited to five years of offsetting payroll taxes.

“What are the regulations on controlled groups?”

When businesses that share common ownership are working on a qualifying project, the R&D tax credit amount will be calculated by the gross receipts of both businesses. We need to look at those businesses together. When we are calculating the R&D credit, we’re going to need to combine any qualifying spend in activities of both of the businesses, any gross receipts of both of the businesses and the calculations.

One significant drawback of the two companies claiming the R&D credit is that one of the companies could prohibit the other from qualifying for a payroll credit:  We need to think about the first years of gross receipts when we’re trying to claim a payroll credit. One of those businesses could disqualify the other one. One’s been around for 10 years and has had qualifying spend and gross receipts for 10 years. And then we’ve got a startup company under the same ownership. That startup company could be disqualified from the payroll credit because of the history in the other business.”

When companies are jointly applying for an R&D credit, they need to consider the limitations of their differing histories and how it could affect their credits. 

“Can internal-use software be used to claim an R&D tax credit?” 

Companies that develop internal-use software can apply for R&D tax credits under narrow circumstances.The internal use software does not qualify unless it meets this high threshold of innovation test. The company is undertaking financial risk in the development work, that the software that they’re developing is truly unique, and it’s not otherwise available in the market.

Although the tax code’s limitations are still in place for internal-use software, the definition of “internal-use” was narrowed by The Protecting Americans from Tax Hikes (PATH) Act of 2015.  Now the definition of internal-use software where it could be something that was exclusively used internally in your business and not sold to third parties, we’re now looking at something that is truly only used within your business and never touches an outside party.More businesses can now apply for R&D tax credits because their software is no longer classified as internal-use. For more information on who qualifies for R&D tax credits, visit Gusto’s Federal R&D Tax Credit overview.

Learn more about R&D tax credits and Gusto People Advisory

If you want to learn even more about R&D tax credits, watch the full webinar here. Also, make sure to check out Part One and Part Two of this webinar article series if you haven’t already.

Applying for and claiming R&D tax credits can seem like an overwhelming task for your clients, which is why it’s important that you have the skillset and resources to advise them through the process. Consider signing up for Gusto People Advisory services. With Gusto, you’ll earn your People Advisory Certification so that you can better advise your clients, and you’ll gain access to services that will help your clients claim R&D credits. If you want to learn more about Gusto People Advisory services, click here.

Gusto Editors Gusto Editors, contributing authors on Gusto, provide actionable tips and expert advice on HR and payroll for successful business management.
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