The IRS likes to complicate our lives, and their instructions for Form 6765 are just as daunting as everything else. They refer readers to the Internal Revenue Code, and unless that is something you peruse for pleasure reading, you likely aren’t familiar with it.
If you want to learn how to receive a tax credit for increasing research activities, keep reading. We’ve put all the IRS jargon into layperson’s terms, providing you with everything necessary to receive a tax credit for research activities.
What Is IRS Form 6765?
The purpose of IRS Form 6765 is to calculate and claim Research and Development (R&D) tax credits. It provides tax credits for increasing research and experimental activities relating to developing or improving processes, software, or products.
The rules for receiving R&D credit are in Internal Revenue Code §41. The credit is available for eligible expenses relating to qualifying research activities.
Benefits of this credit include the following:
- Reduces federal and state tax liability
- Increases the company’s cash flow and market value
- Lowers business effective tax rate
- Allows businesses to retain more profits
When filing, you indicate where to apply the credit. Qualifying small businesses may use it to offset their regular and alternative minimum tax or apply it against payroll taxes.
Form 6765 has four sections you need to complete to receive credit.
Sections A and B
You can use two calculation methods when determining your R&D tax credit. If you use the regular method, you will complete section A. If you use the Alternative Simplified Credit method, you complete section B.
You do either section A or section B, not both. To determine which is best, figure out your tax credit using both methods, then use the one most beneficial to your company.
The regular research credit is 20% of all current-year qualifying expenses over a specific base amount. Depending on whether you are a startup or established, determining the base amount involves detailed calculations.
The alternative credit method requires you to find the difference between the qualifying expenditure amount in the current year and 50% of the average qualifying expenditure for the prior three tax years. You then multiply the difference by 14% to arrive at your R&D credit.
To calculate your Section A or Section B credits, you must determine whether your expenses qualify as eligible research activity. You may claim three kinds of costs:
- Salaries—only those paid for qualified services performed by an employee
- Supplies—computer rentals, molds, parts, other base materials
- Contract work expenses—paid for services meeting the R&D criteria if costs are only for those services
You will need to substantiate your expenses with documentation.
At the end of Form 6765, you can take a reduced credit. This option will reduce the amount of R&D tax credit but eliminate any unfavorable taxable income adjustments. It can also make the preparation of state tax returns easier.
After you quantify your R&D credit for the current year, Section C will direct you to other forms and schedules. You will need to report the amount of your R&D credit on those forms. This varies depending on your business structure.
The final section of the form is where you may indicate your desire to use some or all of your R&D credit to offset your payroll tax obligation for the current year. This is allowable up to a maximum of $250,000.
You transfer the amount you elect to use for payroll taxes you note on Form 8974. The payroll tax offset becomes available quarterly after you file your federal income tax return.
When to File Research Activity Credit
Filing Form 6765 takes place with your company income tax return by the extended due date of your tax return.
There is a standard three-year look-back from the filing date of your return to amend your return and receive the R&D credit. If you have yet to claim the credit and believe you are eligible, you may still be able to obtain your credit.
The IRS has a four-part test that activities must meet to qualify for the R&D credit.
The activity must have a permitted purpose. This means the intent is to make or improve a process or product that will enhance the item’s reliability, performance, function, quality, or cost efficiency.
The intent of the activity must be to eliminate technical uncertainty. This involves developing or improving a product or process relating to design, technique, methodology, inventions, or formulas.
The activity includes the process of experimentation. This means the idea is to eliminate or resolve technical uncertainty. The process consists of evaluating alternatives and approaches through simulation, modeling, prototyping, trial and error, or other methods.
The process is technical in nature. This means it must rely on the hard sciences of computer science, chemistry, biology, engineering, or physics.
The expenses you incur while performing qualifying activities apply to your credit, including computer leasing, contractor research, supplies, and employee salaries. You may claim employees performing the activities and their supervisors and first-line managers who support them in those activities.
The employee expenses are usually 85% or more of the total qualifying expense. The balance is supplies and contractor expenses. With contractor research, you may claim 65% of the cost.
While many expenses meet the qualifications, you may not claim the following:
- Research after starting commercial production
- Research to adopt an existing product for an existing customer
- Duplicating a process or product already in existence
- Marketing research studies or surveys
- Research for internal use software
- Research outside the U.S., a U.S. territory, or Puerto Rico
- Humanities, arts, or social sciences research
- Research receiving funding from a grant, organization, government, or person
- Cost of fixed assets necessary for business operations
Make sure you work with your Form 6765 specialist to determine whether the expenses you claim meet the IRS qualifications. You may not claim the same costs for two tax credits.
Documents You Need
When claiming R&D credit using Form 6765, you will need the following documents:
- Form 6765—Credit for Increasing Research Activities
- List of R&D activities qualifying for credit
- Wage reports
- Supplies and other research expenses and receipts
- Time-tracking information or allocation of employee time for W-2 taxable wages you are claiming for credit
- Contracts and other documentation for outsourced R&D activities
- Design drawings, blueprints, progress reports, test records, and marketing material showing the impact and process of research
Regardless of their entity’s structure, all businesses must file Form 6765 to claim the R&D tax credit.
Considerations About Claiming Credit for Research
Since 2002, there have been changes to Form 6765 every year. This makes it difficult for anyone other than those with a strict dedication to handling tax credits to make sure they are calculating the most credits available.
Accounting staff and Certified Public Accountants may need to catch up on things in this constantly changing credit. A professional specializing in Form 6765 will be up-to-date on what you can and cannot claim.
A specialist in Form 6765 knows what documents are necessary for proving your claim should the IRS question your deductions. Thanks to your tax credit professional’s guidance, your proof will be ready.
Get Help With Form 6765
ERC Today specializes in helping businesses claim tax credits. If you need help completing Form 6565 R&D tax credit, call ERC Today at (833) 469-0939.
We can help you maximize the amount you claim, ensuring everything you claim is eligible, and you have the documentation necessary to prove your position.