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Changes on the Horizon for R&D Tax Credit

November 08, 2021

The rules for both recording and reporting the Research and Development credit could change in 2022. Businesses with research and experimental expenses will want to plan ahead...learn more.

Major changes to the tax treatment and filings requirements of Internal Revenue Code Section 174 research and experimental (R&E) expenditures are scheduled to take effect next year.

R&E expenditures generally refer to R&D costs in the experimental or laboratory sense and include costs related to activities intended to discover information that would eliminate uncertainty about the development or improvement of a product.

New Regulations Require Amortization

First, changes required by the Tax Cuts and Jobs Act (TCJA), which seemed far off and potentially unlikely to ever take effect when the law passed in late 2017, are now set to begin in 2022 unless Congress acts to delay implementation.

Old Rules

Currently, businesses can either opt to:

  • Deduct R&E expenditures, including software development costs, in the year incurred or paid, or
  • Capitalize and amortize the costs over at least five years.

New Rules

The new law requires companies to capitalize all of their R&D costs, including software development costs, incurred in tax years beginning after December 31, 2021. This means that beginning in 2022, your company would no longer be permitted to deduct R&D expenses in the year they were incurred. Instead, these costs must be amortized over five years for expenses incurred in the United States — and 15 years for those incurred outside the country.

New IRS Filing Requirements for Credit Claims

The Internal Revenue Service (IRS) has issued new filing requirements for any taxpayer filing an IRC Section 41 R&D tax credit claim for refund. While the tax credit has been available for years, this is the first time the Service is asking for specific and detailed information on the actual tax filing.

New Requirements

The new IRS requirements, sets forth what information taxpayers must include for research credit refund claims. Per IRS News Release 2021-203, in order for a R&D tax credit claim to be considered valid, the taxpayer must:

  • Pinpoint all the business components to which the Section 41 research credit claim relates for that year.
  • Identify all research activities performed (for each business component) and name the individuals who performed each research activity, as well as the information each individual sought to discover.
  • Specify the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year (using Form 6765, Credit for Increasing Research Activities).

Companies have a grace period until January 10, 2022, after which time this information will be required with a timely filed Section 41 research credit claims for refund. Additionally, there will be a one-year transition period during which taxpayers will have 30 days to perfect a research credit claim for refund (prior to the IRS' final determination on the claim).

Action Required

A budget reconciliation bill has been introduced that would delay implementation of the requirement to capitalize R&E costs until 2026. Proposals to delay or even repeal this provision have had bipartisan support in the past, however, prudent businesses should plan as if the new tax treatment will take effect in 2022.

Additionally, a good quality R&D study or tax credit claim should already contain much of the information required by the latest IRS filing requirements, but now is the time to review your documentation and prepare for the IRS’ renewed campaign to scrutinize R&D tax credits.

Contact our tax specialists for more information.

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