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Qualifying for and Claiming Your R&D Credit

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Qualifying and Claiming Your R&D Credit

How can your clients qualify for and claim R&D tax credits? 

Now more than ever, it’s critical that you advise and assist your clients in receiving all available tax credits. Small businesses often overlook R&D tax credits, but your clients may be eligible.

In this post, you’re going to learn about R&D tax credit studies, how to calculate your client’s tax credits, and how to apply your client’s credits to their taxes. This article will give you a great deal of practical advice that will save your clients money, so let’s get started!

R&D tax credit studies 

Small businesses often view undergoing an R&D study as a daunting task, but you can help them through the process and simplify it for them.

Using our onboarding process you can help your clients identify qualified research expenses and activities during the year that can be used towards claiming the R&D tax credit. We will show you the connection between the qualifying activity and the qualifying spend for the credit. 

In short, R&D studies show the connection between qualifying activities and qualifying spending to determine their eligibility for R&D credit.

How do you qualify for R&D credit? 

The IRS has created a four-point qualification test to find out if your company qualifies for R&D tax credits:

  1. Purpose – The purpose of your research and development activity must create a new or improved function, performance, reliability, or quality for a business component.
  2. Eliminate uncertainty – Businesses that qualify for the R&D tax credit must encounter a problem with a high degree of technical uncertainty and try to solve it using their own procedures.
  3. Technology – The research must be technical in nature—and to be considered technical in nature, an activity must heavily rely on a hard science. 
  4. Experimentation  – According to the IRS, the process of experimentation must include simulation, evaluation of alternatives, systematic trial and error, testing, modeling, and refining.
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How much do you receive in your R&D tax credit? 

After the R&D study evaluates the qualifying project with all four tests, it then evaluates the qualifying expenses of the project. Once the test evaluates qualified expenses, you can calculate an estimate for how much your client will receive in their R&D tax credit.

After combining the qualifying expenses of employee wages, contracting expenses, and supplies, you can expect your client to receive between 7% and 10% of the spent amount in their R&D tax credit. Many tests and evaluations go into an R&D study, which is why you need to advise your clients and help them through the process. With Gusto’s People Advisory Certification program, you’ll learn all the necessary tools for helping your clients through R&D studies, and you’ll also learn several other important consulting skills, like payroll, benefits, and HR

Calculating your client’s R&D tax credits

Once your client’s qualified project has undergone an R&D study, it’s time to calculate your client’s credit. Gusto makes calculating and presenting credits to your clients easy and convenient: 

By using Gusto you can create documentation for calculating state and federal tax credits easily and painlessly. When calculating your client’s credits through Gusto, you’re comparing your client’s spending amount in a given tax year with a base period.

The two methods that determine the base period are the regular method and the simplified method. You should consider both methods to maximize your client’s R&D tax credit.

The regular research credit method is calculated as 20% of the current year spend that exceeds some base amount. And that base amount as written in the tax code is looking at activity in years 1984 through 1988. Many of your clients may not have activity going back quite that far, and they’re going to fall under the startup rules where we’re going to look at their activity in years 5 through 10 that the company was doing R&D work. Under the alternative simplified method, we are looking at the current year’s spending compared to what happened in the three years prior to the current year. That credit is going to be calculated as 14% of the current year spent compared to 50% of that three-year average.

Using both the regular and alternative simplified method is essential for getting your client the most R&D tax credit available. When you use Gusto, you calculate your client’s tax credit using both methods so that you can present them with the best option.

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In addition to calculating your client’s tax credit, it’s also essential to keep all documentation related to how they qualified for the credit. The IRS might contact your client about their R&D tax credit, so their documentation must be readily available. Fortunately, if you use Gusto to conduct an R&D study, you can easily obtain the documents that prove your client’s eligibility and present them to the IRS. 

Using your client’s R&D tax credits

Once you’ve calculated your client’s R&D tax credit, you need to explain to your client how they can use their credit. One method in which they can apply their credit is by offsetting their payroll taxes. The process of using an R&D tax credit to offset payroll taxes will differ depending on what payroll company your client uses.

There are different options for processing the R&D credit through payroll companies just depending on what the individual payroll company does. In some cases, they’re going to claim that credit at the end of the quarter when they file 941, and your client will receive a refund check back from the IRS [that’s] based on the amount of credit they were able to use. Some payroll companies don’t support the credit at all. And in those cases, your only option for being able to utilize the credit is to amend your quarterly payroll tax returns to include the credit information.

Gusto makes offsetting your client’s payroll taxes incredibly easy. Through Gusto Pro, your clients can automatically change their payments to the IRS based on their R&D tax credit: 

Gusto has an easy process where the credits are utilized in real-time. And what that means is they reduce the amount of tax that they’re collecting and depositing with the IRS with each payroll run during the quarter. So at the end of the quarter, your client has paid in only what they owe after these credits are applied. So they’re essentially getting a piece of that credit with each payroll run during the quarter. This can allow the client to receive their credits up to six months earlier than they might in some of these other situations.

With Gusto, you don’t need to worry about communicating with your client’s payroll company to offset payroll taxes, and your clients will receive their credits faster.

In addition to applying the R&D tax credit to offset payroll taxes, you can apply the credit to your client’s income tax. When looking at the income tax credit, this is, again, just a general business credit. It’s a non-refundable general business credit that’s going to the income tax return. If the business does not have taxable income in that year to use the credit to offset, they do have the ability to carry those credits forward for up to 20 years.

Even if your client is not paying income tax for this fiscal year, they can push the credit forward to receive an income tax credit in the future. This is especially useful because many startups do not make enough money to pay income taxes, but they’re developing and improving technology that qualifies them for R&D credits. 

In addition to carrying credits forward, your client can also amend previous returns with R&D tax credits. 

You can go back and amend the federal tax return or amend state returns and claim those income tax credits. You generally have about a three-year statute of limitations in order to do that. As long as the statute of limitations is not run, they do have the ability to go back and claim those credits for earlier years. With a payroll tax credit, you don’t have that flexibility. The credit against payroll taxes needs to be made on the originally filed return.

Although you can amend a previous return to claim income tax credits, you cannot amend a previous return to claim payroll tax credits. 

Advising your clients on how to claim their R&D tax credits can be challenging, but when you use Gusto, you’ll gain access to experts and software that will help you advise your clients as they use their tax credits to offset payroll or income taxes.   

Learn more about qualifying and claiming R&D tax credits 

Many factors affect your client’s eligibility for R&D tax credits, which may seem overwhelming, but Gusto is here to help take the guesswork out of it and get your clients the R&D tax credits they deserve! When you use Gusto’s R&D tax credit services, you can evaluate and keep documentation of your client’s R&D eligibility. 

Gusto makes the process of claiming R&D tax credits simple. We update your client’s payments to the IRS based on their tax offsets, so they immediately benefit from their R&D tax credit. We also offer an easy-to-use client dashboard that keeps you informed about what years your clients claimed R&D tax credits and how much they claimed. If you’re ready to help your clients receive R&D tax credits, check out Gusto People Advisory services here

Gusto Editors
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