When filing for R&D tax credits, one of the first questions that may come to mind is how much your credit will be. Taxpayers can choose from two calculation methods to calculate the R&D tax credit: the regular research calculation method (RRC) and the Alternative simplified credit method (ASC). The calculation you select determines how much credit you will receive, making it crucial to choose correctly to maximize the credit.
Regular Research Calculation Method
The regular research calculation method is 20% of all qualifying expenditures for the current year exceeding a specific base amount. Businesses can calculate the base amount by multiplying the fixed-base percentage by the average gross receipts from the previous four years.
- For example, if a company has qualifying research expenses (QREs) for the past four years, divide the aggregate QREs by the aggregate gross receipts over the same period to determine the fixed-base percentage
- Take the lesser of the fixed-base percentage calculated or 16%
- Multiply the fixed-base percentage by the average annual gross receipts from the previous four years to determine the base amount
- Take the greater of the base amount calculated or 50% of the current year’s QREs
- Subtract the minimum base amount from the current year’s QREs
- Multiply the result by 20%
Organizations that have not claimed the credit in the past or do not have at least four years of expenditure data will find it challenging to use this method. Recently established companies will find the ASC tax credit calculation method easier.
Alternative Simplified Credit Method
The alternative simplified credit method is a less complex calculation method that makes the R&D tax credit accessible to more businesses. However, the ASC calculation generally results in a lower tax credit percentage. The ASC is calculated by:
- Determine the average of the company’s QREs for the past three years.
- Multiply the average by 50%
- Subtract that number from the current year’s expenses
- Multiply that number by 14%
If an organization does not have QREs for any of the past three years, the tax savings equal 6% of QREs for the current year.
R&D Credit for Payroll Expenses
Companies can use either calculation method to offset up to $250,000 in employer social security payroll expenses. However, only certain businesses can qualify. Qualifying small business must have less than $5 million and five years or less in gross receipts for the year it claims R&D credit.
Electing Reduced Credit
For both methods, there is also an option to take a reduced tax credit by electing a 280(c) form. Electing to accept a reduced credit amount can be helpful if taking the full amount raises your taxable income to a higher tax bracket. Taking the entire credit amount can subject companies to an increased tax rate as they are receiving additional income.
For example, S-corporations on the verge of a higher tax bracket may want to receive a reduced credit to avoid getting into a higher one. On the other hand, C-corporations have a consistent tax rate and should not opt for a reduced credit.
In addition to the federal R&D tax credit, many states offer state-level credits businesses can receive. To maximize tax savings, it is crucial to become familiar with your state-level R&D tax credit regulations.
Selecting the correct calculation method can be a daunting task for small businesses. MainStreet does the heavy lifting so you can dedicate more time to your organization. Contact us to start saving money today!