Research and development tax credits (R&D) are a federal dollar-for-dollar offset of income tax liability that can help startups save on their tax bill. The federal government created R&D tax credits in 1981 to encourage companies to innovate by investing in research and development in response to declining R&D investment in the 1970s. There is no limit to the amount of R&D tax credit companies can receive to offset their payroll taxes.
In addition, many states provide a state-level R&D tax credit. Each state has different criteria residents must meet to qualify for their credit. Companies can simultaneously claim federal and state-level credits if they are in a state that offers a state-level credit. Our comparison highlights aspects of both tax credits.
To claim the federal R&D tax credit, business owners must complete Form 6765, Credit for Increasing Research Activities. This form documents how much your qualifying research activities (QRAs) are worth and which calculation methods to use. Companies can choose from the regular research credit method and the alternative simplified calculation.
The calculation method determines the percentage of qualifying research expenses (QREs) the credit will equal. If you choose the traditional calculation, the credit is 20% of QREs over a base amount. However, newer businesses without a history of tax returns generally cannot qualify for R&D tax credits using the regular research credit method.
On the other hand, the alternative simplified credit method provides a lower tax credit percentage than the standard calculation. Still, it can be easier to claim for new companies or those claiming R&D tax credits for the first time.
Like federal-level credit, state-level R&D tax credit is a dollar-for-dollar credit equal to a percentage of qualifying research and development costs. The rate differs between states, and every jurisdiction has unique rules on what types of research qualify, QRA percentage calculations, and eligible industries.
State-level R&D tax credits can significantly differ from their federal-level counterparts. For example, to qualify for Florida’s R&D tax credit, businesses must be classified as C corporations and be in a sector that falls under “target business industries,” including aerospace, information technology, and more. Other states may offer larger percentages of state-level QREs as their tax credit, with Louisiana topping the list at 30% for businesses with less than 50 employees.
Moreover, if you have conducted qualifying research and development activities in multiple states with a state-level tax credit, you can file a claim in each state.
Just as organizations must conduct R&D activities in the U.S. to receive credit from the federal government, each state mandates companies to perform qualifying activities within their borders. Regardless of whether you claim federal or state-level R&D tax credit, you must be able to verify that your organization is conducting qualifying research activities and keeping detailed records of the entire process plus related expenditures.
Government agencies especially want to see documentation of qualifying research activities as they happen. However, estimates can be acceptable as long as businesses substantiate them with a thorough explanation. The most crucial criterion to fulfill is to have a well-documented claim to maximize the chances of approval while reducing the probability of an IRS audit.
How to claim both at once
When filing for state and federal-level credits, you must complete Form 6765 for the federal credit and any additional documents your state requires, such as Kansas’ Schedule K-53 or Georgia’s Form IT-RD. Business owners must submit each form to the corresponding jurisdiction.
While there are notable differences between the federal and state-level R&D tax credits, both can save you money on research and development activities. However, claiming R&D tax credits is often a laborious and time-consuming process. MainStreet helps your business claim as many credits as possible, allowing you to reinvest time and money into your organization. Contact us so we can pass your savings on to you.