Upcoming Changes to the R&D Tax Credit

Overview

The Research and Development (R&D) tax credit is a permanent federal tax credit available to manufacturers and other businesses that conduct research and development activities domestically in the United States. To qualify for the R&D credit, the taxpayer must have the following activities and expenditures associated with those activities:

• The first activity includes those that are intended to remove or reduce technological uncertainty at the outset of a project that relates to the development or improvement of the business component or design.
• The second activity relates to any physical, biological or computer science and/or engineering.
• The final activity relates to new or improved business components that seek to improve products, processes, internal-use computer software or inventions to be sold or used by the taxpayer.

In order for any of the following expenditures to qualify for the credit, they must first meet the above-mentioned activities. The expenditures that can qualify include wages paid to employees, supplies used and consumed, contract research expenditures paid to a third party allowed at 65% of the actual cost incurred and basic research payments to qualified educational institutions or scientific research organizations at 75% of the actual cost incurred.

There are two ways to calculate the R&D credit: the Regular Method and the Alternative Simplified Method. The methods are similar, but the Regular Method determines the base amount by calculating qualified research expenses (QREs) to gross receipts from 1984 to 1988 or using a formula that is based on years that R&D activities began with a limit of 50% on current year QREs. While the Alternative Simplified Method takes an average of the past three years and is adjusted each year. The Regular Credit yields a credit of 20% while the Alternative Simplified Credit yields a 14% credit.

New Filing Requirements

The IRS has issued new filing requirements to reduce audits on the R&D credit by requiring taxpayers claiming the credit to report specific and detailed information. The grace period for this filing requirement continues until January 10, 2022, with new requirements going into effect on January 11, 2022. The new requirements will apply only for AMENDED returns; all timely filed tax returns are exempt from this new 2022 filing requirement.

The IRS will have a one-year transition period after the grace period where the taxpayer has 30 days to correct their R&D credit claim before the IRS makes its final determination. This was recently clarified by Holly Paz, Deputy Commissioner in the Large Business & International division of the IRS. The new requirements for these filings are as follows:

• List of all business components that relate to the claim
• For each identified component, describe the research activities performed, along with the names of the individuals who performed the qualified activities
• For such qualified activity, include information on what each individual sought to discover
• Qualifying costs must now include details on:
  • Employee wages claimed
  • Supply costs claimed
  • Contract research costs claimed
• Include a declaration signed by the taxpayer under penalties of perjury

While this new requirement first appears to be an overwhelming amount of documentation to compile, it is most likely already included in any formal R&D study completed.

Future R&D Tax Credit Changes

Set to begin for tax years after December 31, 2021, The Tax Cuts and Jobs Act of 2017 eliminates the option to deduct R&D expenditures and will require taxpayers to capitalize such costs and amortize over five years (180 months) starting at the midpoint of the tax year in which the qualified expenditure is paid or incurred.

Summary

The changes in the R&D tax credit filing requirements are for Amended tax filings only and will begin January 11, 2022. Those taxpayers filing timely should continue to claim their R&D credit the same as in past years. As for the change in recognition of the R&D credit scheduled to start in January of 2022, taxpayers who plan to claim the credit in the future should pay attention to the changes, if any, set forth in the coming legislation. If you have any questions or would like to discuss further, please contact a member of HBK Manufacturing Solutions at 330-758-8613 or manufacturing@hbkcpa.com.