Archive for R&D Tax Credits

Offsetting Section 174 R&E Software Development Tax Liability With R&D Tax Credits

Offsetting Section 174 R&E Software Development Tax Liability With R&D Tax Credits
Section 174 Changes Impact R&D Tax Credits for Software

The new changes to Section 174 have a significant impact on software development costs. For tax year 2022, any cost that has been paid or incurred related to software development is now considered a Section 174 R&E expenditure. This means it must be capitalized and amortized over 5 years (15 years for foreign software development).

Many favorable provisions are made temporary due to the budgeting constraints of Congress, making yearly extensions normal and expected. It is important to note that the research expenses being addressed by this provision in the TCJA are not just the same as those provided for in the R&D tax credit rules. These general research costs are much broader.

If the current unfavorable tax treatment of research expenses does not get fixed, companies could see larger tax bills and therefore need the benefits of R&D tax credits even more.

Which Software Development Costs fall under the new Section 174 R&E Amortization rules?

While guidance related to what costs constitute Section 174 Expenditures is still vague, potential expenditures can include:

  • Salaries and wages including employer costs
  • Software licensing
  • Equipment rental costs
  • Occupancy costs, including office rent and research facilities costs
  • Travel expenditures that have been incurred for R&E purposes
  • Heat, light, telephone bills, and similar overhead utility costs
  • Depreciation
  • Dues and publication expenses that have been incurred for R&E purposes
  • Attorney fees or filing fees related to patents

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What Is The Benefit Of The R&D Tax Credit?

What Is The Benefit Of The R&D Tax Credit?
What is the Research And Development Tax Credit?

The R&D tax credit, also known as the Research and Development tax credit, was created as a way to incentivize U.S. based research and development activity. The Protecting Americans from Tax Hikes (PATH) Act in 2015 made this a permanent tax credit and extended the benefits to startup companies. The credit enables businesses of all sizes to reduce their federal income tax for qualified research expenses. These expenses must be for qualified research activities.

What Is The Benefit Of R&D Tax Credit?

Claiming the R&D tax credit can potentially result in significant cost savings. The benefits include:

  • Increasing Cash Flow
  • Federal and State Dollar-for-Dollar Income Tax Reduction
  • Claim Credits for Open Tax Years Going Back 3-4 Years
  • Reducing Your Tax Rate

    How To Claim The R&D Tax Credit

    A taxpayer can claim an R&D tax credit, on their timely filed tax return including extensions for a given year and a taxpayer can amend prior returns to claim the credit. For amended tax returns, this can typically be claimed for the previous 3 years.

    The credit is claimed by filing IRS Form 6765, Credit for Increasing Research Activities (for the year in which the qualified expenses were paid or incurred).
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The IRS 4-Part Test For R&D Tax Credits Explained

The IRS 4-Part Test for R&D Tax Credits Explained
The R&D 4-Part Test

Imagine the 4-part test as a sturdy bridge connecting your R&D activities to tax credit rewards. Each part acts as a pillar, ensuring your project meets the eligibility criteria:

1. Permitted Purpose – What Problem Are You Solving?

The core of your R&D activity must be to develop or improve a product, process, software, formula, or technique. This means your project aims to address a technological challenge, not simply fulfill routine business needs.

2. Technological in Nature – Is It Brainy Enough?

Hostels, co-living spaces, and even shared vacation homes can leverage cost segregation for common areas like kitchens, bathrooms, laundry facilities, and entertainment zones.

3. Process of Experimentation – Trial and Error for Success

Your project should involve a systematic experimentation process. This means actively seeking solutions through trial and error, testing different alternatives, and changing your approach based on the results. Simply following established procedures doesn’t qualify.

4. Technological Uncertainty – Are You Pushing the Boundary?

The R&D activity must address unknowns or limitations in technology, design, or engineering capabilities. You’re venturing into unchartered territory, not just making minor improvements or using well-established techniques.

Additional Considerations

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Learn How To Receive United Kingdom R&D Tax Credits

Learn How To Receive United Kingdom R&D Tax Credits

Companies are currently able to claim tax credits for their Research & Development in the UK via two routes, both administered by HMRC. These UK government incentives are designed to encourage innovation by rewarding businesses who work to improve or overcome challenges and uncertainties in their products and processes.

One route is for small and medium size businesses (SMB), the ‘SME R&D tax credit scheme’ (in the UK SME stands for small and medium enterprises). Whilst for larger companies it’s the ‘Research and Development Expenditure Credit (RDEC)’.

Which UK R&D Tax Credits Scheme is Right for Me?

Usually it is the size of your business that decides which scheme to use, but there are other factors that need to be taken into account so it’s important to get specialist advice.

What is the Value of R&D Tax Credits in the UK?

The calculation for SMBs means that companies could claim back up to 33% of the amount they spent on qualifying R&D, however for expenditure on or after  April 1, 2023, the rates will be lowered. From that date, the maximum will be 18.6% for companies with revenue loss, or up to 27% if the company is R&D intensive. For tax purposes, an R&D intensive SMB has qualifying expenditure which represents 40% or more of their total expenditure.

For SMBs the enhancement rate for R&D expenditure on or after April 1, 2023 will be 86% (reduced from 130%) and the tax credit rate reduced to 10% (from 14.5%). R&D intensive companies can still claim a tax credit at 14.5%.

For companies who claim under the RDEC scheme the expenditure incurred on or after April 1, 2023 will increase from 10% of their R&D spending refunded up to a rate up of 15%.

R&D Tax Credits for SMBs

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Written by | Posted in R&D Tax Credits • TaxConnections

Understanding The R&D Tax Credit And How To Claim It

Understanding The R&D Tax Credit And How To Claim It

The R&D tax credit is a valuable incentive provided by the government to encourage businesses to invest in research and development activities. It is a tax break that rewards companies for their innovation and technological advancements.

So, how does the R&D tax credit work? Essentially, it allows eligible businesses to claim a tax credit against their qualified research expenses. These expenses can include wages, supplies, and even contract research costs. By claiming the credit, businesses can reduce their overall tax liability, freeing up funds that can be reinvested back into their R&D efforts.

Now, let’s explore the benefits of claiming the R&D tax credit. Firstly, it provides a significant financial boost for businesses, particularly those engaged in innovative activities. The credit can result in substantial tax savings, allowing companies to allocate more resources towards research and development.

In addition to the financial advantages, the R&D tax credit also enables businesses to enhance their competitiveness. By investing in research and development, companies can develop new products, improve existing ones, and gain a competitive edge in the market. This credit encourages businesses to stay at the forefront of technological advancements, fostering growth and innovation.

Furthermore, the R&D tax credit can positively impact your business by stimulating job creation. As companies invest in R&D activities, they often need to hire skilled professionals to support their research efforts. This leads to job growth and contributes to the overall economic development of the business and the community.

Step-by-Step Guide to Claiming the R&D Tax Credit

Understanding the process of claiming the R&D tax credit is essential to ensure you receive the maximum benefit. Here is a step-by-step guide to help you navigate through the claiming process:

  1. Evaluate your eligibility:
    Determine if your business activities qualify for the R&D tax credit by reviewing the IRS guidelines and criteria.
  2. Identify qualifying activities and expenses:
    Identify the specific research and development activities and related expenses that qualify for the tax credit. This may include wages, supplies, and contract research expenses.
  3. Document your R&D activities:
    Maintain detailed records of your R&D activities, including project descriptions, timelines, and documentation of technological uncertainties and experiments conducted.
  4. Calculate the credit:
    Calculate the R&D tax credit using the appropriate method, either the Regular Credit or the Alternative Simplified Credit (ASC), based on your business size and financials.
  5. Prepare and file your tax return:
    Complete the necessary tax forms, such as Form 6765, and include the R&D tax credit calculations and supporting documentation with your tax return.
  6. Engage in an audit defense strategy:
    Prepare for potential audits by ensuring your documentation is thorough and accurate. Seek guidance from R&D tax credit experts to minimize any potential risks.
Working with R&D Tax Credit Experts

Claiming the R&D tax credit can be complex, especially if you are unfamiliar with the intricacies of tax regulations. Collaborating with R&D tax credit experts can streamline the process and maximize your benefits. These professionals have the expertise and experience to:

  • Identify eligible activities and expenses: R&D tax credit experts can help you identify all qualifying activities and expenses, ensuring you don’t miss out on any potential credits.
  • Optimize credit calculations: By leveraging their knowledge of tax laws and regulations, experts can help you accurately calculate the R&D tax credit to maximize your benefits.
  • Prepare and defend your claim: R&D tax credit experts can assist in preparing your tax return and supporting documentation to withstand any potential audits or inquiries.

By partnering with R&D tax credit experts, you can navigate the complexities of the claiming process with confidence, ensuring you receive the full benefits you deserve.

Have a question? Would you like an introduction to Rachel Bishop?

Contact Eric Larson for an immediate introduction or make a request at this link: https://sourceadvisors.com/tax-connections-contact/ 

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Offsetting Section 174 R&E Software Development Tax Liability With R&D Tax Credits

Offsetting Section 174 R&E Software Development Tax Liability With R&D Tax Credits

The new changes to Section 174 have a significant impact on software development costs. For tax year 2022, any cost that has been paid or incurred related to software development is now considered a Section 174 R&E expenditure. This means it must be capitalized and amortized over 5 years (15 years for foreign software development).

Many favorable provisions are made temporary due to the budgeting constraints of Congress, making yearly extensions normal and expected. It is important to note that the research expenses being addressed by this provision in the TCJA are not just the same as those provided for in the R&D tax credit rules. These general research costs are much broader.

If the current unfavorable tax treatment of research expenses does not get fixed, companies could see larger tax bills and therefore need the benefits of R&D tax credits even more.

Which Software Development Costs fall under the new Section 174 R&E Amortization rules?

While guidance related to what costs constitute Section 174 Expenditures is still vague, potential expenditures can include:

  • Salaries and wages including employer costs
  • Software licensing
  • Equipment rental costs
  • Occupancy costs, including office rent and research facilities costs
  • Travel expenditures that have been incurred for R&E purposes
  • Heat, light, telephone bills, and similar overhead utility costs
  • Depreciation
  • Dues and publication expenses that have been incurred for R&E purposes
  • Attorney fees or filing fees related to patents Read More
Written by | Posted in R&D Tax Credits

Qualifying Expenditures For The R&D Tax Credit

Qualifying Expenditures For The R&D Tax Credit

Qualifying expenditures for the R&D tax credit include salary and wages, supply costs, computer rental or lease, and contractor costs.

Salary & Wages

There are generally three categories of employees performing research:

  • Employees that perform Direct research. This includes people specifically performing the activities, (researchers, engineers, CAD associates, project managers, etc.) and is the core of the credit.
  • Employees that Directly Supervise research. This includes anyone who is directly supervising the employees doing the direct research.
  • Employees that Directly Support research. This includes anyone who is directly supporting research efforts. For example, let’s say a researcher has a direct assistant who is strictly taking notes and accumulating data. Their time assisting the direct researcher is also included. Similarly, a person testing prototypes and first articles would also be considered direct support.
Supply Costs

If you are prototyping and testing materials, the cost of those materials can be included. For example, the materials associated with prototype builds are research costs as are the costs of materials used in the evaluation of new formulations of beauty products can be included as supply costs.

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Common Misconceptions About R&D Tax Credits

Common Misconceptions About R&D Tax Credits

The Research & Development (R&D) tax credit can enable businesses to increase cash flow and savings, reduce the Federal income tax rate, and receive Federal and State dollar-for-dollar income tax reductions. Specifically, a wide variety of businesses can potentially offset up to $500,000 in payroll tax liability for qualifying activities.

However, there are many misconceptions about the R&D tax credit that prevent businesses from taking advantage of it.
Here are the 6 most common myths:

Myth 1: The R&D Tax Credit is Only For Businesses with a Large Amount of Revenue

Many people falsely believe the R&D tax credit is only for businesses with a large amount of revenue. However, businesses with a revenue of less than $5 million in the current year are able to claim the credit.

Myth 2: Start-Ups Can’t Claim the R&D Tax Credit

Start-ups and small businesses can claim the R&D tax credit. If your business has 5 years or less in revenue, you are eligible for the credit (as long as you meet the additional qualifying criteria, which include having $5 million or less in revenue in the current year and conducting qualifying research activities).

Myth 3: The Business Must Conduct Scientific Research to Claim the Tax Credit

A business does not have to conduct scientific research in order to claim the R&D tax credit. There are a large number of activities that qualify, including (but not limited to) automating or improving internal manufacturing processes, designing tools or fixtures, integrating new equipment, developing financial pricing models, developing data centers, integrating APIs and similar technologies, and many more.

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What Do UK Tax Leaders Think Of Recent Changes To The R&D Tax Landscape? Evolution Or Revolution

What Do UK Tax Leaders Think Of Recent Changes To The R&D Tax Landscape? Evolution Or Revolution

At the end of November 2023, we held our second roundtable discussion. Following the success of our first event in April 2023, it is important to bring leaders together again to discuss the many recent changes that have impacted our industry in a short space of time.

Set in the beautifully festive boardroom at Fortnum and Masons we gathered 15 R&D tax leads from the top 50 firms and Tax dispute experts as well as a Shadow Minister, to ensure we had a discussion that represented multiple stakeholders and diverse viewpoints.

What makes a competent professional?

HMRC is increasingly questioning what makes a competent professional within the enquiries they are raising. HMRC seem to be narrowing the scope of what is necessary to define a competent professional. This is a frustrating position. There was collective agreement on how important the role of the competent professional is but also that HMRC’s current stance is now too narrow.

This further led to alarming examples where businesses choosing to protect their Intellectual Property through trade secrets are being penalised, and their claims are being assessed as not compliant.

HMRC’s lack of engagement and training

The frustration over the lack of engagement with HMRC is continuing to be a concern with little improvement since our conversation in April. The inability to speak to a specific individual who is allocated to the case and therefore informed and knowledgeable about the specifics of that case is resulting in incorrect communications leading to a lack of clarity on areas of enquiry. This highlights the need for HMRC to invest in training and education for their staff to ensure consistency in their messaging.

The lack of consistency and apparently minimal training of HMRC staff are leading to genuine claims being challenged and then for commercial reasons, companies are deciding not to fight when they should. If the aim was to address the level of fraudulent claims, then it now seems that HMRC is also acting as a barrier to genuine claims meaning we are seeing genuine businesses walking away from the UK innovation market. This is being made more frustrating as it could be rectified but if it isn’t, we certainly risk the payback of previous R&D subsidies. It was noted that the core payback metrics of spillover and additionality are long term (10 years+) so the actions now will continue to damage the UK’s position on the global stage.

Announcement of the merged R&D tax relief scheme – but what’s the policy?

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Make Your R&D Tax Credit Defensible

How to Make Your R&D Tax Credit Defensible

Claiming the R&D tax credit can potentially help your business offset increased cash flow. However, simply completing IRS Form 6765, Credit For Increasing Research Activities, doesn’t guarantee the IRS will approve your claim. 

Learn a few key things you can do to ensure your R&D tax credit is defensible in the case of an IRS or state audit.

1. Understand Which Activities are Considered Qualified Research Activities

One of the most important things you can do to make your R&D tax credit defensible is understand what qualifies as research activities. Qualified research activities are specific efforts to develop new products, fabrication processes, or software, or improve existing ones. This can include activities such as developing firmware and risk management systems, designing tools and fixtures, automating manufacturing processes, and much more.

To determine if your research activities are eligible under the R&D tax credit claim, you’ll need to ensure each passes the Four-Part Test as outlined in IRC §41(d). Any company that wants to claim the R&D tax credit must satisfy each of the criteria of the Four-Part Test, including the Business Component Test, Technological Uncertainty Test, Process-of-Experimentation Test, and Technological-in-Nature Test. Learn more about the Four-Part Test here.

2. Make Sure You Meet the Additional Qualifications

In order for a taxpayer to claim the R&D tax credit, there are a few minimum qualifications that must be met in addition to the above-mentioned qualified research activities. These additional requirements include having 5 years or less in revenue and having less than $5 million in revenue in the current year. It’s important to note that qualifications can vary by state, so you’ll need to understand these specific qualifying factors within your state when claiming the tax credit.

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Written by | Posted in R&D Tax Credit Study • R&D Tax Credits • TaxConnections

Might You Be Eligible For An R&D Tax Credit?

Might You Be Eligible For An R&D Tax Credit?

R&D Tax Credits?  We’re a bottling plant, not a science lab.  I doubt we’re eligible…”

A common misconception is that the R&D Tax Credit is only available to businesses engaged in traditional scientific experimentation – pharmaceuticals, biomedical research, and the like.  However, the federal tax credit is intended to incentivize companies in a plethora of industries to develop new and improved products and processes.   This powerful, permanent, dollar-for-dollar reduction isn’t just for the so-called “white-coat industries.”

And it’s worth looking into… The credit provides improved cash flow, offering up to 10 cents in benefit for every qualifying dollar identified in a performed study.  It may be carried back one tax year and forward up to 20 years.

A business in almost any industry can be eligible, if it meets the Capstan Criteria:

1.       Research is happening to create or improve a business component.  (A “Business Component” is whatever the business is trying to develop, be it a product, process, technique, formula, etc.)

2.       The research is trying to eliminate uncertainty.  (How can we make this?  Can we even make this?)

3.       The research involves experimentation of some kind where different alternatives are evaluated.  (Scientific laboratory work, 3D modeling, architectural design, computerized simulations, etc.)

4.       The research is technological in nature.  (Keep in mind, that doesn’t mean that the final product is part of a technical field.  The fidget spinner, for example, is just a toy.  But researching the shiniest paint that won’t flake off the toy does require a technological analysis.)

Once eligible, a business can take Qualified Research Expenses (QRES), which are the costs involved in performing the research.  Wages, supplies/materials, cloud hosting, and third-party contractor fees can all be expensed using the R&D Tax Credit.

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The IRS Issues Revised R&D Tax Credit Instructions

The IRS Issues Revised R&D Tax Credit Instructions

On December 15th, the Internal Revenue Service issued an early release draft of instructions for IRS Form 6765 entitled “Credit for Increasing Research Activities”, to properly reflect legislation regarding the determination of qualified wages that impacts Lines 5 and 24 from the December of 2020 revision.

It should be duly recalled, pursuant to legislation enacted in December of 2020, wages for qualified services do not include:

  • Wages paid to or incurred for any employee after December 31, 2020 and before July 1, 2021, if the employer uses the same wages to claim the Employee Retention Credit (“ERC”) on an employment tax return such as IRS Form 941 entitled “Employer’s Quarterly Federal Tax Return”; and
  • Wages paid to or incurred for any employee generally after December 27, 2019 and before April 17, 2021, if the employer uses the same wages to claim the 2020 qualified disaster ERC on IRS Form 5884-A entitled “Employee Retention Credit for Employers Affected by Qualified Disasters”.

As a reminder, do not file draft forms and do not rely on draft forms, instructions, and / or publications for filing until finalized by the Service. The draft instructions for IRS Form 6765 can be reviewed at https://www.irs.gov/pub/irs-dft/i6765–dft.pdf The Service is also currently accepting comments in connection to the draft instructions at https://www.irs.gov/forms-pubs/comment-on-tax-forms-and-publications All tax filing forms and instructions are expected to be finalized by the Service before the end of January 2022.

Have a question on R&D Tax Credits? Contact Peter J Scalise.

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