4 Simple Steps to Estimate a Business's R&D Tax Credit
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4 steps to quickly estimate the size of a business's potential R&D Tax Credit
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Determine the business's engineering payroll. That is, how much in W2 wages were paid to engineers and engineering managers, plus any/all amounts paid to engineering contractors.
According to IRS data from 2014 (the most recent data available), wages and contractor expenses make up over 84% of Qualified Research Expenditure (QRE) across all industries.
In addition to the wages of the engineering team, engineering managers, and contractors, the wages of employees supporting the engineering team, along with other expenses like supplies and some rental costs may qualify as research expenses, as well.
However, for the purpose of a simple estimation, engineering payroll likely makes up the bulk of QRE and is easiest to identify or estimate, so we'll use that number as the basis for our simple estimate. -
Estimate how much of the team's time was spent on Qualified R&D Activities.
For an early-stage company, an estimate of 70% is a good, conservative place to start.
The IRS allows businesses to claim 100% of the W2 wages for employees who spent "substantially all" (80% or more) of their time on Qualified R&D activities, so if you estimate the Qualified R&D amount to be 80% or more for salaried employees, you might as well use 100% instead.
Note: This rule does not, however, apply to contractors. In fact, the IRS requires you take a 35% haircut from any contractor expenses you're claiming toward QRE, right off the top. -
Multiply engineering payroll by your estimated Qualified R&D percent (from #2) to get your estimated Qualified Research Expense (QRE) for the year.
Example: A startup has 10 software engineers each earning $90,000 in wages and 1 contractor who was paid $100,000 in the tax year.
W2 employees: 10 engineers * $90,000 salary = $900,000
Contractors: 1 contractor * $100,000 contractor payment * (1-0.35) = $65,000
Total engineering payroll = $965,0000
Qualified Research Expenditure = $965,000* 70% (estimated Qualified R&D %) = $675,500 -
Multiply QRE by 6-10% to get your estimated R&D tax credit.
The 6-10% range represents variables including the federal credit + any state R&D credits, the amount of Qualified R&D, and the age of the company (startups developing brand new products may be engaged in more qualifying activities than existing companies). We'll use 8% in the example below to keep it simple:
Example continued: Qualified Research Expenses of $675,500 * 8% credit = $54,040 R&D tax credit
