Developing new products and services is one of the key ways to expand and grow your freelance business—and it’s also an activity that can benefit you from a tax perspective, thanks to the federal and state Research and Development (R&D) Tax Credit programs. It is estimated that the R&D tax credit and other related tax breaks save U.S. businesses more than $12 billion annually.
Read on to learn how your freelance business can get its share of these cash incentives.
First, the Basics of the R&D Tax Credit
R&D tax credits provide cash incentives for companies conducting R&D in the United States. The purpose of these incentives is to encourage research and development in a wide variety of industries and for businesses of all sizes. The government has recently expanded its list of eligible industries—including software development, IT, engineering and many others—which means more businesses can benefit from these tax credits.
The credit is equal to a certain percentage of a business’ qualified research expense (QRE) in excess of a base amount. There are many QREs than are eligible, including the salaries of employees and supervisors who are conducting research, supplies and, if applicable, research services that are contracted out.
Another key point about the R&D Tax Credit is that you don’t have to split atoms in a research lab to be eligible for it. You simply need to invest resources (your time and/or money) toward the advancement and improvement of products and processes.
Starting in 2016, qualified small businesses had the option to elect to claim up to $250,000 for research activities as a payroll tax credit in the form of a refund. In addition, the government recently updated R&D tax credit regulations so that eligible taxpayers can now retroactively claim the credit on all open tax years, which currently includes returns for 2014, 2015, and 2016.
Yes, Your Small Freelance Business or Startup May Qualify
You don’t need to run a global conglomerate to qualify. R&D tax credits are widely available for small freelance businesses and startups. In fact, as long as your business is engaged in qualifying research and development activities such as designing, developing or improving products, processes, techniques, formulas, inventions, software, or any number of other items, you may meet the IRS eligibility requirements which include:
- Operating a startup, in business for less than five years.
- Having less than $5 million in gross revenue.
- Filing form 6765 with your income tax return
You Also Need to Meet the IRS Four-Part Test
Your R&D tax credit eligibility also requires that your product or process development work meets this IRS four-part test:
- Development of a new or improved product or process. You must create a new product, process technique, formula, invention, patent or software, or improve an existing one. For improvements, there must be tangible and significant changes in performance, functionality, quality, reliability or cost.
- The R & D must rely on technological processes: Hard sciences, such as engineering, physics, chemistry, biology, or computer science must be applied in the development a new product or process to qualify for the credit.
- Elimination of Uncertainty: You must demonstrate that you’ve attempted to eliminate uncertainty about the development or improvement of a product or process.
- Process of Experimentation: You must demonstrate through modeling, simulation, systematic trial and error or other methods that you’ve evaluated alternatives for achieving the desired result.
Don’t Forget to Check State and Local Credits
Another pointer: Many states offer R&D tax credits beyond those offered by the federal government, so you should take a look at what is offered in the state(s) where you do business. For example, New York State created the Excelsior Jobs Program which provides several refundable tax credits, including those related to research and development tax. New York's R&D tax credit allows taxpayers to claim up to 50 percent their federal R&D tax credit amount that relates to R&D expenditures in the state (with a 3 percent cap).
Federal and state filing requirements vary for R&D tax credits, so you may benefit from working with a CPA to ensure that you have looked at all of your eligible QREs and that you have the required documentation in hand to maximize your tax credit opportunities.
Get Ready to Claim Your Share of Available R&D Tax Credits!
Given the significant funds available in the form of R&D tax credits, it is worth exploring if your business qualifies for them—so you can claim your share of the estimated $12 billion available!
Jonathan Medows is a New York City based CPA who specializes in taxes and business issues for freelancers and self-employed individuals across the country. He offers a free consultation to members of Freelancer’s Union and a monthly email newsletter covering tax, accounting and business issues to freelancers on his website, www.cpaforfreelancers.com which also features a new blog, how-to articles, and a comprehensive freelance tax guide.
Jonathan is happy to provide an initial consultation to freelancers. To qualify for a free consultation you must be a member of the Freelancers Union and mention this article upon contacting him. Please note that this offer is not available Jan. 1 through April 18 and covers a general conversation about tax responsibilities of a freelancer and potential deductions. These meetings do not include review of self-prepared documents, review of self-prepared tax returns, or the review of the work of other preparers. The free meeting does not include the preparation or review of quantitative calculations of any sort. He is happy to provide such services but would need to charge an hourly rate for his time.