Federal Research and Development (R&D) Tax Credit

The four-part test is the framework for determining eligibility for R&D tax credits—watch our video tutorial here.

Companies must meet the following criteria to qualify for these credits: 

1. Technological in Nature: The research aims to discover new information or develop new technology. 
   
   • R&D efforts should rely on “hard” science (physical or biological science, engineering, or computer science) rather than “soft” science  (psychology, sociology, economics, education).
2. Business Component (Permitted Purpose): The results of the research should aim to develop new or improve the company's products, processes, or software better by improving functionality, performance, reliability, or quality.
   • You must create value or some form of technological advancement.
3. Process of Experimentation: Substantially all the activities involved in the research must constitute a process of experimentation. 
   • This involves systematic testing and evaluating different approaches to achieve the desired result.
4. Technological Uncertainty: The research must be aimed at resolving technological uncertainty. 
   • You must show that at the start of the research, there was uncertainty about how to achieve the desired outcome, and that the information you needed to achieve the desired outcome was not available to you.

Make sure you document your research activities in case your company should get audited by the IRS.

Before you complete the steps to see if you qualify for R&D tax credits with Gusto, you'll need to gather various information.

Watch our video tutorials:

• Company information (part 1)
• Company information (part 2)

Company information

We need details such as the first year of R&D activities, the first year of revenue generation, and the tax year-end date.  Additional company information needed includes:

• Company type for LLC: Depending on how your LLC is structured and taxed, you'll need to specify its type. Options include "partnership", "sole proprietorship", "S Corporation", or "C Corporation".
• Your company’s EIN: You can locate your company's Employer Identification Number (EIN) in the top-right corner of your company’s Corporate Federal Tax Return form.
• Parent company and subsidiary: A parent company controls or owns the majority of another company, termed as a subsidiary. Ownership is determined by the percentage of shares held, typically at least 51%.
• Accounting basis: This refers to how you maintain your books or general ledgers, also specified in your tax return.
• State of business: The state where your business is physically located.
• Impact of revenue and profitability: Your revenue and profitability status affect how your R&D credits can be used. 
• Example: Startups with annual gross receipts less than $5 million and less than 5 years with gross receipts may have different options for credit utilization.

Wages and contractors

For Gusto customers, wages and contractor payments made through Gusto can be imported directly via the Gusto API. You can also upload W-2’s manually by choosing your provider and uploading PDF versions of your W-2s.

Expense calculation for R&D

Expenses like contractor fees and supplies are used to calculate your R&D tax credit. Expenses can also be imported through our CODAT integration. We accept general ledgers through direct integration with supported bookkeeping platforms (Quickbooks Online, Quickbooks Desktop, Xero, and Freshbooks). Hard copies of Form 1099s can also be submitted, but not general ledgers.

If you cannot connect your expense platform, select Other Provider and upload PDF versions of your 1099s.

Required tax returns  

It’s best to provide your company’s four years prior federal tax returns (complete filed copies). This helps determine the average annual gross receipts, crucial for accurate R&D credit calculations.

• Gross receipts: Fill in the gross receipts information from the tax returns to assist in the calculation process.

Watch our video tutorials for more information on the entire process:

• Pre-qualification
• Company information (part 1)
• IRS 4-part test
• Company information (part 2)
• Review and submit

Steps in Gusto

1. Sign in to your Gusto account.
2. Click the Tax Incentives section.
3. Under the “Available credits” section, click See if I qualify in the Research & development tax credit tile.
4. Fill out the survey.
5. Click Save and continue.
6. If you qualify for R&D tax credits, click Continue to Gusto R&D.

Our team will assess your eligibility for the credit—we’ll look at your payroll data, calculate the credit, and provide an estimated credit for your review and approval. There's also an opportunity to increase the credit by uploading additional expenses (contractor costs, supplies, etc.). Our Gusto R&D Tax Team is available via chat to answer any questions you have along the way.

• Qualified wages are calculated based on your employee's contribution to R&D efforts—depending on how much time is devoted to R&D activities will help determine what percentage each employee’s salary can qualify for the R&D tax credit. 
• Other qualified expenses are used to help us increase your total R&D tax credit. They’ll provide us with insight to your contractors and supplies that qualify for R&D credit. If you’re able to provide your accounting records (a complete General Ledger file), our software can help determine R&D eligibility. 

Calculation methods

There are two methods of calculating the credit: 

• Regular method
  • Under the regular method, the base amount is determined by averaging annual gross receipts over the four years preceding the calculation year and multiplying it by a fixed base percentage. The credit is then calculated based on the difference between total qualified research expenses (QRE) and the base amount, using the lower of the two figures, which is then multiplied by 20%.  Four years of tax returns are needed to calculate the credit using the regular method.
• Alternative Simplified Credit (ASC) method
  • The ASC method uses QRE from the past three years to establish the base. The credit is calculated by halving the average QRE from the three prior years, subtracting it from the current year's QRE, and multiplying the result by 14%. If there are less than three years of QRE, the credit is simply 6% of the qualified research expenditures for the current year.

280C Election

To avoid "double-dipping," where R&D expenses are both credited and deducted, companies are required to reduce the amount of their capital account by the amount their R&D tax credits exceed their allowable R&D expense deduction. To avoid this, companies can make a 280C Election on a timely filed tax return. This reduces the R&D tax credit by the corporate tax rate, avoiding the adjustment mentioned above from being needed.  

How this works with Gusto

1. We’ll determine the calculation method based on various factors, such as qualified research expenses, gross receipts, and the duration of your company's qualified R&D activities.
   •  If you provide tax returns, we’ll use the regular method; otherwise, we’ll use the alternative simplified method. 
   • If you provide adequate data for both methods, our team assesses which one yields a higher credit.
2. Our software looks at job titles and suggests percentages based on similar companies to yours in both employee size, and industry. 
   • These are initial estimates that might require adjustments.
3. You’ll review the estimated percentages, and adjust them as needed.
   • If you’re unable to make adjustments, either chat with us online, or schedule a call—both options will have links in your account.
   • Watch our video tutorials for more information: 
     • How to review your credit
     • How to approve your credit

Gusto can help determine which utilization method is right for your business—watch our video tutorial here. 

Payroll offset

Companies meeting the IRS' "startup rules" can leverage R&D credits to offset their payroll taxes, specifically the employer-paid portion of the social security and medicare tax. To qualify as a startup, a company must adhere to two essential rules:

1. Rule 1: The company has less than five years of gross receipts/sales. The five years are the year in which the credit is claimed and the four years prior.
2. Rule 2: The company has less than $5 million in gross receipts/sales in the tax year for which the credit is claimed.

Note: After the fifth year, payroll tax offset becomes unavailable. The offset option is limited to a timely filed tax return or a superseding tax return.

Income tax offset for profitable pass-through companies

Profitable pass-through companies, like S-Corps and Partnerships, can apply R&D credits to offset personal income tax liability of their shareholders, partners, or LLC members.

A pass-through entity is defined as a business where their profit flows through to owners or members and are taxed under the individual income tax—these entity types don’t pay income taxes at the business level.

• These credits should be reported on Schedule K-1 and Form 3800 of Form 1040, making sure that owners can benefit from the tax incentives associated with R&D activities.

Claim credits from prior years by amending returns

The option to offset income tax is only available by amending a company’s prior-year returns. If you do not want to amend, the credit cannot be used and will be forfeited. 

If a company decides to amend its tax return to claim R&D credits from a prior year, a Declaration Statement must be filed with the amendment—our Credit Defense team will develop this report for you.

Carry-forward options

If a company does not have taxes to offset in the now, or is not profitable, both federal and state R&D credits can be carried forward and recorded as deferred assets on your company’s tax return balance sheet, meaning these credits remain unused until you can offset your income tax liability.

Alternatively, if you have prior year tax liabilities, you can apply your current-year R&D tax credits to the prior year by amending the return. Typically, credits can only be carried back one prior year.

A few reminders

• Federal credits can be carried forward for up to 20 years.
• Each state has its own rules regarding the expiration of credits. 
• Example: California's state credit can be carried forward indefinitely.
• Businesses can also carry back the R&D tax credit for one year to apply the credit retroactively by amending the prior year return.

The table below shows what forms are needed.

	C-Corp	S-Corp	Partnership	Sole Proprietor
Tax form	Form 1120	Form 1120-S	Form 1065	Form 1040, 1040-SR, Schedule C
Form 6765 (R&D form)	Yes	Yes	Yes	Yes
*Form 3800 (general business credit)	Yes, filed with Form 1120	Yes, filed with shareholder’s Form 1040	Yes, filed with partner's Form 1040	Yes, filed with Sole Prop’s Form 1040
*Schedule K-1	No	Yes (Schedule K-1, Form 1120-S)	Yes (Schedule K-1, Form 1065)	No

*Form 3800 and K-1 are not needed for payroll tax offset utilization.

Form 6765 is the form used to claim R&D tax credits and must be filed with your Federal Income Tax Return—watch our video tutorial here.

There's a section at the bottom of Form 6765 to allow QSBs to elect to apply some or all of the credit towards offsetting payroll taxes.  

Important: If using the credit towards payroll tax, be sure Section D/Box 41 is checked. If it's not checked, the credit will be used towards income tax.

For a Qualified Small Business (QSB), the payroll tax credit can be first claimed on the business tax return for the first quarter after filing the income tax return with Form 6765 reflecting the payroll tax election section.

Profitable companies

• If a profitable company files an on-time tax return without marking the payroll election section, the R&D credits are used as a liability tax offset at the time of filing. Any unused credits can be carried forward to offset future income tax liability.
• If the tax return is filed on time without Form 6765, the company must amend the return to include Form 6765 and claim the credits. Starting January 10, 2022, a Declaration Statement is required for any refund claims from the IRS. Gusto's R&D Tax Credit Team can assist with this statement.

Non-profitable companies

• For companies that were not profitable and filed on-time tax returns without the payroll election section, the credits can be carried forward. These credits can be used in future years when the company generates income tax liability. Credits can be carried forward for up to 20 years.
• If the tax return is filed on time without Form 6765, the company has two options to report these carry-forward credits:
  • Amend the prior year's return to include Form 6765, claim the credit, and report the credit balance as a deferred asset on the balance sheet.
  • Do not file an amendment and simply report the credit balance on a carry-forward schedule.

Whether to use the R&D credit as a payroll offset should be based on the company’s preference and advice from their tax preparer.

Using the credit to offset payroll taxes must be filed on Form 8974, which is attached to your quarterly payroll tax returns (Form 941). This form should be submitted to your payroll provider to incorporate the credit into your payroll tax return.

The credit will be applied against employer payroll taxes quarterly, beginning the first calendar quarter after filing your federal income tax return. 

To receive your credit quickly, timing is everything. Form 6765 needs to be filed with your tax return, so keep these dates in mind:

• End of quarter deadlines
  • Q1: March 31
  • Q2: June 30
  • Q3: September 30
  • Q4: December 31
• Extension filing deadline
  • October 15
• Payroll providers turnaround
  • 1-30 days (estimate)
• IRS turnaround
  • 8–10 weeks (estimate)

The timing of your refund depends on a couple of things:

• When you filed your income tax return and Form 6765
• How quickly your payroll provider files payroll taxes 
• The IRS processing time  

By meeting the March 15th (S-corps and Partnership) or April 15th tax return filing deadline (C-corps and Sole Proprietorships), you can have your payroll provider process tax credits. 

Only one credit can be claimed at a time until the full amount is used up. You’ll be charged $100/month in any month in which you claim the R&D Tax Credit in real time.

• In 2023, the IRS updated the guidelines to allow for the R&D tax credit to be applied to employer Medicare once the employer's share of Social Security is exhausted. For now, Gusto will not be applying the real-time credit to Medicare. Gusto will report any Medicare credit amounts on the quarterly filings and the IRS will refund the company. 

Important: This setting only appears in your account if there's a remaining balance to apply credit to. It also depends on when your accountant filed your most recent business income tax return because you're eligible to claim the credit on the first day of the following quarter. For example, if your return was filed in May, then the credit period begins July 1st (the first day of the next quarter) and runs through June 30th of the next year.  

Steps for an accountant to set up real-time R&D Tax Credits

1. Sign in to your Partner dashboard.
2. Go to the Clients section.
3. Select the client's name.
4. Click Go to client account in the top-right corner.
5. In the client's account, click the Settings section.
6. Click the Customization tab.
7. Next to “Real Time Federal R&D Tax Credit,” click edit.
8. Toggle to Enabled.
9. Click Save.

You'll see the R&D tax credit savings on the next payroll you process.

Steps for an admin to set up real-time R&D Tax Credits

1. Go to the Settings section of your admin account.
2. Click the Customization tab.
3. Next to “Real Time Federal R&D Tax Credit,” click edit.
4. Toggle to Enabled.
5. Click Save.

You'll see the R&D tax credit savings on the next payroll you process.

Cancel real-time federal R&D tax credits

If you do not wish to take the R&D Tax Credit in real time anymore, you may cancel at any time.

Steps for an accountant to cancel R&D tax credit in real time

1. Sign in to your Partner dashboard.
2. Go to the Clients section.
3. Select the client's name.
4. Click Go to client account in the top-right corner.
5. In the client's account, click the Settings section.
6. Click the Customization tab.
7. Next to “Real Time Federal R&D Tax Credit,” click edit.
8. Toggle to Disable.
   • You'll be billed for the full $100 monthly fee even if you disable mid-month.
9. Click Save.

Steps for an admin to cancel real-time R&D tax credits

1. Go to the Settings section.
2. Click the Customization tab.
3. Next to “Real Time Federal R&D Tax Credit,” click edit.
4. Toggle to Disable.
   • You'll be billed for the full $100 monthly fee even if you disable mid-month.
5. Click Save.

Once your company is set up to claim the credit, you can review summary reports about your federal R&D tax credit in the Reports section of your account.

After you’ve completed an audit of your company’s R&D expenses with your accountant, and filed Form 6765 with your business’ income tax return, your accountant can set you up to claim the credit in Gusto. Only one credit can be claimed at a time until the full amount is used up.

Your accountant will claim the credit for you using their accountant profile. They’ll need a few things first:

• Your business’ most recent annual income tax return;
• Form 6765;
• Any previous Form 8974, if you’ve already claimed part of the credit

Important: Your accountant will need to submit all the necessary information to Gusto by the 15th of the last month of a given quarter in order for it to be included in the quarterly filing.

The R&D Credit cannot start being claimed until the quarter after your Federal Tax Return has been filed.

• Example: If an admin enters in 3/15/20 (Q1) as the Income Tax Return filing date, the credit cannot not start being applied until 4/1/20 (Q2).

Gusto will then complete and file Form 941 as well as Form 8974, so your company can claim the credit and receive the refund. The IRS estimates the refund will take 10–12 weeks to arrive after we file.

Resources

• Form 941 instructions
• Form 6765 instructions
• Form 8974 instructions
• IRS final ruling

Once your company is set up to claim the credit, you can review summary reports about your federal R&D tax credit in the Reports section of your account.

There are a few steps you need to take as an accountant to help your clients claim R&D tax credits.

Part 1: Credit for qualified research

1. Sign in to your Partner dashboard.
2. Go to the Clients section.
3. Click the Actions menu on the far-right.
4. Click Third-party tax credit service.
5. Select the type of business income tax return this company uses.
6. Select the Fiscal Tax Year this company uses.
7. Enter the date this company filed their tax return.
   • The filing date is used to determine the first eligible quarter that the credit can be claimed.
8. If this company filed under a different Federal EIN at any point in their corporate tax year, the previous Federal EIN is required for the Federal R&D Credit filing.
9. Enter the total Federal R&D Credit claimed.
   • This amount can be found on Line 44 of Form 6765.
10. Click Save & Continue.

Part 2: Previous credit claims

1. Select whether your client has claimed part of this credit on a Form 941 this fiscal year or not.
2. If this company claimed the credit in any prior quarters, enter these values so we may determine their remaining Federal R&D Credit.
3. Click Save & Continue.

Part 3: Before you submit

1. Review the information to make sure everything is accurate. 
2. Once you are ready, click File Tax Credit. 
3. Determine if you’d like this credit to be taken quarterly (free), or in real time.

The client should see the refund from the IRS about 8–12 weeks following the 941 filing (if not claiming the credit in real time).

Supporting documents are documents that originated during the development year and support your R&D claim by demonstrating the pieces of the 4-part criteria test. We suggest organizing your documents by business components and by the related tax year. 

Examples of supporting documentation for each of the criteria can be found below.

R&D 4-part test category	Sample document types
Business Component / Permitted Purpose	Project management summaries, technical specifications, whitepapers, new feature releases, brochures, pamphlets, press releases, and other similar documents.
Technological Uncertainty	Meeting minutes, project notes, documents submitted to management for research project approval, and emails.
Process of Experimentation	Testing reports, experiment records, brochures, pamphlets, annual internal reports, field and lab summaries, progress reports, and published documents.
Technological in Nature	Jira tickets, code commits, and technical specifications.
Mixed categories	Patents, contracts, letters of agreements, memoranda of understanding, expense details, and payroll records.

• Document the time spent by each employee on qualifying R&D activities.
• Specify the nature of their tasks and the percentage of time dedicated to R&D. 
• Document the experimental process, including any hypotheses, testing methods, and outcomes. 
• Highlight instances where uncertainties were encountered and the steps taken to resolve them.
• Explicitly tie expenses to the R&D project to demonstrate the allocation of resources for qualifying activities.
• If external parties are involved in your R&D activities, maintain detailed documentation of subcontractor agreements and the specific R&D-related tasks they performed. 
• This includes invoices, contracts, and any other relevant documentation.

1. Log into Gusto Pro.
2. Click Refer & Earn in the left navigation.
3. Click R&D Tax Credits.
4. Select Get Started.
5. Share the referral link with your client.

We'll then determine if your client qualifies. If they do qualify, we'll handle the entire study and provide you with the documentation to file.

When your client qualifies for the R&D credit, we’ll provide the revenue share, and send you a referral gift card as thanks. 

There are a few steps you need to take as an accountant to help your clients claim R&D tax credits.

Part 1: Credit for qualified research

1. Sign in to your Partner dashboard.
2. Go to the Clients section.
3. Click the Actions menu on the far-right.
4. Click Third-party tax credit service.
5. Select the type of business income tax return this company uses.
6. Select the Fiscal Tax Year this company uses.
7. Enter the date this company filed their tax return.
   • The filing date is used to determine the first eligible quarter that the credit can be claimed.
8. If this company filed under a different Federal EIN at any point in their corporate tax year, the previous Federal EIN is required for the Federal R&D Credit filing.
9. Enter the total Federal R&D Credit claimed.
   • This amount can be found on Line 44 of Form 6765.
10. Click Save & Continue.

Part 2: Previous credit claims

1. Select whether your client has claimed part of this credit on a Form 941 this fiscal year or not.
2. If this company claimed the credit in any prior quarters, enter these values so we may determine their remaining Federal R&D Credit.
3. Click Save & Continue.

Part 3: Before you submit

1. Review the information to make sure everything is accurate. 
2. Once you are ready, click File Tax Credit. 
3. Determine if you’d like this credit to be taken quarterly (free), or in real time.

The client should see the refund from the IRS about 8–12 weeks following the 941 filing (if not claiming the credit in real time).

If your accounting firm processes payroll through Gusto, third-party R&D tax credits can be claimed for your firm by following the steps below.

1. Sign in to your Gusto Pro account (your accountant profile).
2. Under "Tasks", toggle to Firm. 
3. Click Redeem third-party R&D tax credits.
4. Complete the R&D tax credit questionnaire to claim third-party R&D tax credits.