Aug. 24, 2022

This paid piece is sponsored by Eide Bailly LLP.

A version of this article appeared on eidebailly.com.

Tax credits and incentives are an excellent way to reduce your tax liability and operate your business more efficiently. Unfortunately, there are significant misconceptions regarding the R&D credit carryforward and how it works.

Many companies find themselves not claiming what they are entitled to and misunderstanding how a carryforward tax credit works.

What is a credit carryforward?

A carryforward credit applies a tax credit in a future tax year. It’s a provision within the tax code to allow businesses to take advantage of unused tax credits. There are many reasons why a tax credit could go unused such as operating losses or that the IRS has a maximum limit on how much a business can claim per fiscal year.

Likewise, there’s also a carryback. An R&D credit carryback may be used if an organization has suffered considerable losses in one year and would rather deduct from a previous year’s profits.

Every carryforward and carryback credit has different rules that apply to it.

What is the R&D credit carryforward?

If you have Qualified Research Expenses, you can take any unused R&D tax credits and apply them to a future tax year. Companies may use these credits in bumper years to offset their tax liabilities.

A circumstance where someone may use an R&D tax credit carryforward is when there was a significant investment in research and development that did not result in a profit.

Another scenario where the R&D credit carryforward may be employed is if your business is eligible for a more significant tax credit than what you currently owed or paid through your taxes.

How does the R&D credit carryforward work?

Understanding the value of this tax credit is problematic because it varies based on the type of research activity, whether it was done in-house or contracted out to a third party. On average, this tax credit carryforward is worth anywhere from 5 to 10cents for every dollar spent on R&D activities.

Businesses that decide to carry forward their tax credits may find they can offset their tax liability in future years. The process begins with an R&D tax credit study followed by a formal claim.

If you decide to claim this tax credit, you will be filing IRS Form 6765, Credit for Increasing Research Activities.

The way this research credit carryforward works has changed, however. The 2017 Tax Cuts and Jobs Act passed by the Trump administration eliminated the alternative minimum tax for businesses structured as C-corporations.

The act also allowed businesses to reduce their tax bills using R&D tax credits from the past, present and future. Another change saw part of the tax code amended for tax years from 2018 onward. This amendment stopped businesses from applying more than 80 percent of their net operating losses to their taxable income.

However, this limit set by the Tax Cuts and Jobs Act was suspended in 2020 by the CARES Act. It has been reinstated as the suspension was designed to last for only a single fiscal year.

Supporting documentation for the R&D tax credit

The same rules apply to the R&D tax incentive as any other tax credit. You must maintain copious records to substantiate your expenses. If the IRS audits your business and doesn’t have enough supporting documentation, the tax credit may be rescinded, leaving you with a hefty tax bill.

Some of the types of documentation you should keep records of include:

• Financial records showing payments.
• Business records demonstrating the payments were used for a qualifying expense.
• Breakdown of qualified vs. nonqualified expenses.

As a general rule, the more documentation you have, the better. Maintain an organized recordkeeping system to ensure you don’t get caught out. An intelligent accountant won’t allow you to claim an expense unless it can be firmly substantiated.

The bottom line

The carryforward mechanism for tax credits is a valuable tool in your arsenal to maximize the tax credits available to your business. Even among larger firms, qualifying R&D activities are often overlooked.

Hiring a professional who understands the current rules is vital to ensuring you get the most from your tax credits.

You also need to consider your strategy for carrying these credits forward or backward. Getting the right experts on your side is an investment that can repay itself many times over.

Eide Bailly is the CPA and outsourcing advisory firm that has supported businesses of all sizes to negotiate the difficulties of R&D expenses. To learn more about optimizing your tax returns, contact Eide Bailly now.