Page 9 - Business Insights Technology Industry

RESEARCH AND DEVELOPMENT TAX CREDITS:
EMPOWERING INNOVATION

ONE OF THE BEST INCENTIVES AVAILABLE TO
TECHNOLOGY COMPANIES COMES IN THE FORM
OF THE CREDIT FOR INCREASING RESEARCH CLAIM PROCESS:
ACTIVITIES OR AS ITS MORE COMMONLY KNOW THE
RESEARCH AND DEVELOPMENT (R&D) TAX CREDIT. To claim the R&D tax credit, businesses must file IRS Form 6765, “Credit for Increasing Research
THESE CREDITS CAN HELP SERVE AS A CATALYST FOR Activities,” with their timely tax return. Additionally, retroactive claims can be made by amending prior tax
INNOVATION AND GROWTH, OFFER THE BUSINESS CASE returns within the previous three years.
OPPORTUNITIES TO ADVANCE TECHNOLOGICAL FRONTIERS
WHILE BENEFITING FROM SIGNIFICANT TAX INCENTIVES. ENACTED When claiming the credit, taxpayers have the option of either the Regular or Alternative Simplified Method.
AS A PERMANENT FIXTURE UNDER THE PROTECTING AMERICANS Additionally, the amount of the credit claimed would need to be taken as income in the year of the claim;
FROM TAX HIKES (PATH) ACT IN 2015, THE R&D TAX CREDIT however, in a post-Section 174 capitalization world most taxpayers will opt to take a reduced credit in
INCENTIVIZES RESEARCH AND DEVELOPMENT ACTIVITIES WITHIN THE exchange for the addback given its interaction with the capitalization.
UNITED STATES. ITS SCOPE EXTENDS BEYOND ESTABLISHED CORPORATIONS,
EMBRACING STARTUP VENTURES AND NURTURING A CULTURE OF INNOVATION After claiming on a tax return via Form 6765, technology companies can either use the credit to reduce
ACROSS INDUSTRIES. current taxes, carry forward to future years or under certain circumstances, claim as a reduction of payroll
QUALIFYING RESEARCH ACTIVITIES - FOUR PART TEST taxes due. Many early-stage technology firms will choose to, assuming they qualify, take against payroll
taxes, as this provides the fastest monetization of the credit.
For expenditures to be eligible for the R&D Credit they first must meet all parts of a four-part test. DOCUMENTATION:
► New or Improved Business Component: The IRS considers a business component to be any product, Like with most other tax matters, strong documentation is critical for the taxpayer claiming a Research and
process, computer software, technique, formula or invention to either be held for sale or used in the Development Credit. The documentation should include:
business of a taxpayer.
► What business components were being worked on
► Elimination of Uncertainty: Activities must intend to discover information that was unknown to the
taxpayer as to the design, methodology or capability of the business component. ► Who is working on them and what time was spent on these
► Process of Experimentation: The taxpayer must perform an evaluation of alternatives, including ► Research activities performed
testing, modeling or systematic trial and error to eliminate the uncertainty. The key here is that the ► The information sought to discover
expenses must represent research and development expenses in the experimental or laboratory sense,
which are undertaken for the elimination of uncertainty. In software development, the use of an Agile Fibonacci process is one of the most common approaches to
► Technological in Nature: The expenses must rely on scientific principles or similar, such as keeping this documentation, including the story and process points which help document both the component
and the activities performed, as well as time. The tax court has recently allowed estimates to be used for the
engineering.
time allocations as well, however, they are subject to more controversy.
For most early stage and technology companies, these activities will often revolve around their product SECTION 174 CAPITALIZATION:
offering, both in its initial development and then ongoing features.
In a sense counterintuitive to all of the above, starting in tax year 2022 as part of the Tax Cuts and Jobs
ELIGIBLE EXPENDITURES FOR R&D CREDITS Act businesses were required to capitalize and amortize research and development costs (over 60 or 180
Eligible expenses include qualified wages, supplies and contract research expenses. months), rather than expense outright. The prior law which allowed expensing also intentionally used a
broad definition of Research and Development costs under Section 174 as to allow these to be deducted
► Wages can be for both employees that are directly performing research and their related supervision; easier and quicker. This change has now impacted firms in the complete opposite manner of the R&D
it does not however include any benefits or other costs. The calculation for employees is usually based Credit, by increasing tax bills in an artificial manner by delaying these deductions. While the R&D Credit
on what percentage of their time is spent doing Research and Development activities; if 80% or more and this capitalization are thought of in unison, they are in fact different tax code sections; said differently,
of their time is spent on these activities, then it is considered substantially all is spent in Research and even if a taxpayer does NOT claim an R&D Tax Credit, they still may be subject to this capitalization which
Development and their time is allocated at 100%. will require much of the same analysis. This provision has proven to be wildly unpopular and features
► Supplies are for items of tangible personal property (which can include software) used in the Research bipartisan support for repeal, but as of 2024 still has yet to be repealed.
and Development process. However, specifically excluded from this category are capitalized items.
► Contract research expenses are for amounts paid to 3rd parties for research and can be included
generally at 65% of the incurred amount.
JACOB LUTZ, CPA, MBA
Crucially, one of the requirements of claiming these expenditures is that the activities must be performed in MANAGER
the United States.
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