RESEARCH AND DEVELOPMENT TAX CREDIT

The R&D Tax Credit, first enacted in 1981, has been one of the most valuable credits leveraged by companies. Every year, the R&D credit yields billions of dollars in federal and state benefits to companies engaged in qualifying research. Thousands of companies take advantage of the credit across several industries.

BENEFITS OF THE R&D TAX CREDIT

There are several benefits to realizing the R&D tax credit. These benefits can include the following:

• • Up to 15.6 cents of R&D tax credit for every qualified dollar
  • Dollar-for-dollar reduction in your federal and state income tax liability
  • Improved cash flow
  • Credit carried forward up to 20 years
  • Look back studies can recognize unclaimed credits for open tax years, meaning cash refunds

In addition, The Protecting Americans from Tax Hikes Act of 2015, signed into law on Dec. 18, 2015, modified and made permanent the R&D tax credit. Small businesses may now claim the credit against alternative minimum tax. Additionally, a small business start-up is now able to claim a credit of up to $250,000 against its FICA payroll tax liability if eligible.

DO YOU QUALIFY?

In determining whether your business research activities qualify for the Research & Development Tax Credit, the activities must pass the following four-part test:

              1.    The activity must be intended to eliminate technical uncertainty about the development or improvement of the product or process.

              2.   A process of experimentation must be undertaken to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain at the beginning of the taxpayer’s research activities.

              3.   The activity undertaken must be technological in nature. Whether this test is met depends on whether the process of experimentation utilized in the research fundamentally relies on principles of the hard sciences.  The hard sciences are defined as the physical or biological sciences, engineering or computer science; and

              4.   The activity must be intended to be useful in the development of a new or improved business component of the taxpayer (which means a new or improved product, process, formula, technique, invention or software component).

DOES RESEARCH PERFORMED UNDER A GOVERMENT CONTRACT QUALIFY?

YES.  In addition to the four-part requirement list above, if you perform qualified research under contract, the following two requirements must also be met:

               1.   The taxpayer must retain substantially all of the rights to the research; and

               2.   The amounts payable to the taxpayer under the contract must be contingent on the success of the research (i.e., it should be duly noted that the taxpayer must bear the economic risk of loss).

WHAT QUALIFIES?

If performing a qualified activity, The R&D credit comprises the following types of Qualified Research Expenses:

• • Wages paid to employees for qualified services (including amounts considered to be wages for federal income tax withholding purposes)
  • Supplies (defined as any tangible property other than land or improvements to land, and property subject to depreciation) used and consumed in the R&D process
  • Contract research expenses paid to a third party for performing QRAs on behalf of the taxpayer, regardless of the success of the research, allowed at 65% of the actual cost incurred
  • Basic research payments made to qualified educational institutions and various scientific research organizations, allowed at 75% of the actual cost incurred.

CHANGES TO TREATMENT OF SECTION 174 EXPENSES

Section 174 was modified by the Tax Cuts Jobs Act (“TCJA”) for tax years beginning after December 31, 2021. Taxpayers will no longer be allowed to deduct R&D Section 174 expenses in the year incurred. Businesses will be required to capitalize R&D costs for tax purposes as an intangible asset and amortize over a 5 or 15-year period depending on associated location of where the research was performed.

RULES FROM THE TCJA:

• • R&D expenses must be amortized over a 5-year (domestic) or 15-year period (international)
  • Mid-year convention means only 10% of an expense can be deducted in the year incurred
  • Software development expenses incurred after December 31, 2001, must be treated as an R&D expense and amortized
  • Companies amortizing for the first time do not need to file a 3115; instead, a company can include a notice with their originally filed return

HOW DOES SECTION 174 DIFFER FROM THE R&D CREDIT?

• • The rule change to amortize 174 expenses does not affect the R&D Credit
  • These are two different sections of the Tax Code – 174 and Section 41 (R&D Credit)
  • The calculation of the R&D Credit does not change – only the accounting for the expenses related to research and experimental expenditures
  • Use the R&D credit to help offset the impact on your Taxable Income caused by 174 amortization

WHAT IS INCLUDED IN SECTION 174 EXPENSES? WHAT EXACTLY NEEDS TO BE AMORTIZED?

• • Definitive guidance has not been issued
  • All expenses that qualify to be included in the Section 41 Credit calculation will also be Section 174 expenses and must be amortized
  • Not all Section 174 expenses will qualify for the Section 41 Credit calculation
  • Known differences that should be included in Section 174 amortization are: the 35% of contract research costs that are not allowed for the credit calculation; legal fees for patents; depreciation and overhead expenses for R&D facilities; others depending on your specific situation

HOW CAN WE HELP?

DSF’s experts will help you determine eligibility and aim to maximize research credits.  Our comprehensive service includes a credit study, tax preparation support and complete audit defense. DSF will ensure that your business receives current year federal and state tax savings and is refunded for any prior year tax benefits.  Current legislation allows a business to retroactively claim refunds for these tax credits for up to 4 years depending on the tax jurisdiction.  If you believe you are an eligible business, do not wait to contact DSF to start a risk-free review.  Contact us today to discuss what opportunities you have available.

For immediate assistance or to find out more about your research credit benefits, contact Joel Peterson or call (562) 249-6012