The federal research and development (R&D) tax credit is frequently overlooked by eligible businesses. If you’re among them, you shouldn’t assume you’ve missed the boat—you might qualify to file an amended return to claim the credit retroactively.
Filing taxes alone may feel like a burden without the added step of amending returns, But the effort could prove well worth it when it comes to boosting your cash flow.
What is the R&D credit?
The Sec. 41 credit is designed to incentivize domestic businesses to conduct R&D work in the United States. It generally allows a business doing “qualifying research” to apply a percentage of its qualifying expenses to offset, on a dollar-for-dollar basis, its federal income tax or payroll tax liability.
Unused credits can be carried forward for 20 years or back one year to offset income tax liability in those years. And the option to apply some or all of the credit against your payroll tax liability means you can benefit even if your business isn’t profitable and hasn’t yet incurred income tax liability.
Many businesses miss out on this potentially valuable credit. Some might not even realize they conduct research activities that qualify as R&D (see below).. If you’re among these companies, you should consider claiming the R&D tax credit on a timely filed tax return or amending your tax return to obtain a refund
Do I qualify for the credit?
The IRS has a four-part test for qualifying research activities:
1. The research is performed to eliminate technical uncertainty about the development or improvement of a product or process, including computer software, techniques, formulas, and inventions (the Section 174 test),
2. The research is undertaken to discover information that’s technological in nature. That is, it relies on physical, biological, engineering, or computer science principles. (the technological in nature test),
3. The research is intended for use in developing a new or improved business product or process (the business component test), and
4. Substantially all (generally, at least 80 percent) of the research activities are elements of a process of experimentation relating to a new or improved function, performance, reliability, or quality (the process of experimentation test).
If your business has pursued such research, you may qualify for the R&D credit.
How do I claim the refund if the tax deadline has passed or for a prior tax year?
You’ll need to file an amended tax return with IRS Form 6765, “Credit for Increasing Research Activities.” Unfortunately, though, the IRS has tightened the requirements to claim a refund for the R&D credit on an amended tax return. As of Jan. 10, 2022, the IRS will only accept the claim when you:
1. Identify all the business products and processes (also referred to as “business components”) to which the credit claim relates for the relevant tax year.
2. For each business component, identify all research activities performed, all individuals who performed each research activity, and all of the information each individual sought to discover.
3. Provide the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year. (You can do this using Form 6765.)
You must submit these “five items of information” when you file the refund claim, along with a declaration signed under penalty of perjury verifying their accuracy (in most cases, the signature on your amended tax return serves this function).
Remember, though, that these are simply the threshold requirements to establish the validity of a refund claim. Satisfying them doesn’t mean the IRS will automatically approve the credit—rather it provides grounds for the evaluation of the claim.
What if I used statistical sampling to calculate my credit?
Some businesses use statistical sampling to estimate their qualified research expenses.[BN1] Such sampling is often much easier than reviewing the documentation for each business component.
With this approach, you must provide the information in #1-2 above for all of the units included in the sample. The information in #3 will be reported on Form 6765 you include with your refund claim, based on the sampling.
How should I provide the required information?
The IRS says you should provide the “five items of information” in a signed written statement —rather than producing a large collection of documents. At this point, there’s no need to produce, for example, a credit study. (You should, of course, hold on to any supporting documentation in case your claim is later audited[BN2] .)
But, if you do provide an R&D credit study or other documents, you must specify the exact page(s) supporting a specific fact. The IRS won’t comb through documents searching for the requisite information.
How Can My Business Use the R&D Tax Credit?Finances and Taxes
Which business components do I need to identify?
You’re required to identify all the business components that form the factual basis of your claim.
How detailed do I need to be when identifying research activities performed?
According to the IRS, you must describe what you did, and how you did it, by business component. You needn’t describe the four-part test in detail, but language that only restates the requirements won’t cut it.
Do I need to provide the names of the individuals who performed research activities?
No. You can identify these people by listing their titles or positions.
Suppose a group of employees performed research activities and sought to discover the same information for a single business component. In that case, you can list them by name or title/position for that component and describe the information they sought to discover. In these circumstances, however, you’ll also need to identify the specific number of individuals and each person’s title or position.
How should I present the information?
For each business component, you can present the information on 1) the individuals who performed each research activity and 2) the information each individual sought to discover in a:
- Table, or
To provide the total qualified expenses for each category (wages, supplies, and contract research), you can rely on a properly completed Form 6765.
What if I don’t submit the correct information?
If the IRS deems your claim “deficient,” you’ll receive a letter (Letter 6426C or 6428) that specifies the missing information. During the transition period (see below), you’ll have 45 days to supply the necessary information; the letter will state the exact due date. The process of providing missing information is known as “perfecting” the refund claim.
If you don’t submit the specified information or the IRS determines the claim is still deficient, the agency will reject the refund claim (see below for information on appeals).
How should I provide the missing information?
You can provide it as part of your explanation of the changes to your original tax return—for example, in Part II of Form 1120X, “Amended U.S. Corporation Income Tax Return.” Alternatively, you can give it as an attachment to the refund claim. Either way, make sure you include a copy of the deficiency letter.
Note: The IRS accepts information only on paper, submitted by mail or fax. The deficiency letter will include a fax number. Faxing is the preferred method.
When does the transition period expire?
The transition ( aka grace) period was originally set to run until Jan. 10, 2023. But the IRS has now extended it through Jan. 10, 2024. During the transition period, you’ll have 45 days to perfect a deficient refund claim. After the transition period, the IRS won’t provide any time to perfect, and deficient claims won’t be considered.
How far back can I claim the R&D credit?
The R&D credit isn’t subject to a specific statute of limitations, but taxpayers generally must file a valid credit or refund claim within three years of the date their original tax return was filed or two years from when the tax due on that return was paid—whichever period expires later.
Note: If you perfect a deficient refund claim after the limitations period has run, but before the IRS has rejected it, the claim might be considered filed on the date of the deficient claim—and therefore still valid (assuming you filed the deficient claim before the limitations period expired). So, if the clock is ticking on your limitations period, it might be worth filing a deficient claim now and perfecting it later, instead of forfeiting the credit because you haven’t yet gathered all of the required information.
How long does it take the IRS to process a claim?
The IRS says it will attempt to review R&D credit refund claims as fast as possible and make determinations within six months of receipt of when they receive them.
Can I appeal if the IRS rejects my refund claim?
The IRS appeals process isn’t available for refund claims that are rejected because they’re deficient. And federal courts can review only valid refund claims, so they can’t review a claim denied for being deficient.
On the other hand, refund claims that are disallowed because they were filed past the limitations period are eligible for consideration by the IRS Independent Office of Appeals.