Is it time to get excited about the R&D Credit again?

Over the last few years, the buzz around the Research and Development Credit (R&D Credit) quieted to a faint murmur. The Tax Cuts and Jobs Act (TCJA) of 2017 went into effect January 1, 2022, requiring the capitalization and amortization of specified research and experimental expenses. Though the tax and accounting community expected Congress to change it back to the prior law allowing the immediate expenses of these costs. As we sit here today, the bill stalled in the Senate. The TCJA changed the economics of the R&D Credit. But rumors are swirling that the Trump Administration will reverse the capitalization requirement and restore the immediate expensing of such costs, retroactively to January 1, 2022!

Now is a good time for a refresher on the R&D Credit and who may qualify.

What is the R&D Credit?

The R&D tax credit is a federal tax credit (IRC Sec. 41) intended to incentivize innovation and technological advancement within the United States. The credit offsets a company’s federal income tax liability, dollar-for-dollar, and for certain taxpayers, the credit may be used to reduce their payroll tax obligations.

Would our company qualify for the R&D Credit?

The credit is available to any company, regardless of industry or entity type, provided certain activities are met.

What type of activities would our company need to undertake?

The activities of your business must meet four criteria to qualify for the R&D Credit:

• The R&D activities are conducted to develop or improve a product, process, software, technique, invention, or formula related to the business.
• The R&D activities must be technological in nature, relying on science or engineering principles.
• The R&D activities involve a systematic process of experimentation, such as modeling, testing of hypothesis, or trial and error.
• The R&D activities are designed to eliminate uncertainties.

A sample of these activities may include:

• Development of a product to bring to market or improving an existing product
• Improvement of processes or techniques in manufacturing
• Development of software intended to sell or license to customers
• Experimentation with formulas, such as food and beverage or chemicals
• Testing models and prototypes
• Developing solutions and processes to mass produce a product and bring it to market

This list is not meant to be exhaustive but rather stimulate thought as to the activities your company routinely engages in as part of your normal course of business.

What costs are included in the calculation of the credit?

Includible costs primarily fall under three buckets. These include:

1. Qualified labor – wages of the employees conducting the qualified activities and personnel who support and supervise the qualified activities.
2. Qualified supplies – raw materials or supplies used in the development and testing of prototypes, products, and processes.
3. Qualified contract research expenses – cost associated with work performed by contractors, provided the business and not the contractor bears the economic risk of the work’s success or failure.

Proper recordkeeping is essential to support the credit claimed. This includes the nature of the research and experimentation performed, who was involved and to what extent, and the costs incurred (as described above).

How much is the R&D Credit?

There are two methods to calculate the R&D Credit, the regular fixed-base percentage R&D Credit or the Alternative Simplified Credit (ASC). Each will yield a different result. However, the credit usually amounts to 6% to 8% of the annual eligible costs.

How do we claim the credit?

The credit is calculated using IRS Form 6765 – Credit for Increasing Research Activities. Taxpayers who qualify for the credit in prior years may amend any open tax year to retroactively claim the credit. Credits not fully utilized against income taxes or payroll taxes (if applicable) may be carried forward 20 years to offset future income tax liability.

If the Trump Administration retroactively changes the capitalization requirements discussed earlier, expect a flood of amended returns for the R&D Credit for the 2022 and 2023 tax years.

How can Mpowered Incentives Group help us with the R&D Credit?

We are glad you asked!

Our established processes ensure that your credit is properly calculated, complying with the current and changing tax laws. We provide a comprehensive report supporting the calculation and application of relevant tax laws. Sleep soundly knowing that we stand by our work, defending the credit should the IRS or state taxing authority select the credit for audit.