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Research Tax Credit

Entrepreneurs who conduct research that is technological in nature to develop or improve a business product may be able to claim the research credit, which is part of the general business credit. The research credit is similar to the research and experimentation deduction, however, it is narrower since it only covers costs for research that is technological in nature, amongst other things. By claiming qualifying research activities under the research credit instead of deducting as general research and experimentation costs, you may receive a greater tax benefit since credits directly offset your tax liability. The research credit can give Entrepreneurs a significant tax break, however, it is a complicated and very nuanced credit so be sure to consult with your tax advisor to determine how you should treat your specific research costs.

PROFESSIONAL SERVICES

Jenna is a sole practitioner Lawyer developing a unique way to digitally gather, store and search client records. Last year Jenna spent $25,000 experimenting with different pilot models. Jenna calculated her research credit to be $1,500 under the simplified method (credit amount could vary based on inputs). Accordingly, Jenna claimed the $1,500 credit on Form 3800 as part of her general business credit and reduced her tax liability dollar for dollar (subject to general business credit limits) on line 54 of her Form 1040.

AUTHOR / SPEAKER

Robert, an expert in 16th century art, makes a living giving presentations on various works of art located in museums across the world. Last year, Robert spent $9,000 developing a new process to catalogue historic works of art specifically from the 16th century. Unfortunately, Robert would not qualify for the research credit since his research and experimentation activities were related to the arts. Note however that he may still be able to deduct certain expenses as ordinary and necessary business expenses.

DEVELOPER / ENGINEER

Won is a sole proprietor software developer in his first year of business who is in the initial stages of researching a new application he wants to create to intercept human thoughts. Won spent $8,000 last year researching how he could improve the performance of his pilot product. Using Form 6765 Won calculated his research credit to be $800 using the regular method and $480 using the simplified method. Since Won received a greater tax benefit from the regular method, he included $800 of research credit in Part III line 1c of Form 3800. Note that the total credit amount for each method could vary based on a number of inputs, and that the regular method may not always result in a higher credit than the simplified method.

AUTHOR / SPEAKER

Rochelle is a novelist who constantly challenges herself to improve her writing process. Last year, she spent $2,000 conducting research and experimenting with a new outlining method that could decrease her overall writing time by 20%. While Rochelle's research activities may be beneficial to her business and the related costs potentially deductible as ordinary business expenses, her research activities would not qualify for the research credit since they do not not rely on physical or biological sciences, engineering, or computer science and therefore are not considered to be technological in nature.

ENTREPRENEUR

Ruby lives in San Diego, California and has a business building custom bicycles out of her garage. Ruby recently began researching a process that would allow her to make her carbon fiber bicycle frames both lighter and stronger. In her first year she spent $15,000 on supplies and a legal deposit so she could begin the patent process. Even though some of Ruby's research and experimentation costs could qualify for the research credit, she chose not to claim the credit since her accountant informed her the current year benefit she would receive would be limited as a result of the other general business credits she would be claiming.


WHAT TO KNOW ABOUT THE SUBSTANTIAL PRESENCE TEST

  • If you are conducting research that falls under the definition of Research and Experimentation activities you could qualify to take the research activities credit if your research is being conducted to discover information that is technological in nature, will be used to develop a new or improved component of your business, and substantially all of your research activities are related to a process of experimentation that improves the function, performance, reliability or quality of a product.
  • You may elect to take the regular credit or the simplified credit. The calculation of both methods is complicated and variable based on a number of circumstances specific to your individual business. Accordingly, we will not go into details, however, consider calculating your credit using both methods so you can determine which method will provide you with the greatest tax benefit.
  • Generally, the credit will not be allowed if your research was conducted after the beginning of commercial production of your product, conducted outside the U.S., funded by another person or government, related to certain internal-use computer software, a duplication of an existing process or product or related to social sciences, arts or humanities. Further, the credit may be disallowed if your research was a survey or study or adapted an existing product or process for a particular customer.
  • If you are a Schedule C filer your research credit is calculated using Form 6765, then included as part of your general business credit on Form 3800 before it is finally applied against your tax liability on line 54 of your Form 1040. Note that a number of special rules may apply and reporting requirements may vary depending on a number of factors including your organizational structure (partnership, S-Corp, etc.). If you plan on taking the research credit, we recommend using a tax preparer to help you calculate your credit.
  • If you take the research credit, you must reduce your deduction for research and experimental expenses by the amount of your research credit, or elect to take a reduced credit.
  • The research credit is subject to the constraints of the general business credit. Depending on what other general business incentive credits you take and your total tax liability, your current year research credit may be limited.

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