What to Know When Applying for an R&D Tax Credit Refund Claim

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Last October, the Internal Revenue Service (IRS) Office of Chief Counsel issued a memorandum for taxpayers wishing to apply for the research and development (R&D) tax credit refund claim. The guidance outlines the information the IRS requests for a refund claim to be deemed as valid and to meet the requirements of existing legislation. Subsequently, taxpayers wishing to apply for the R&D refund claim will face an increased documentation burden to meet these standards. Doeren Mayhew’s Tax Incentives Group highlights the memorandum as well as key background information on new capitalization rules so you can apply for the R&D refund claim with confidence before the looming deadline.

Background on the Credit

The R&D tax credit was originally implemented in 1981 to incentivize the development of new products and processes in different industries. It generally applies to expenditures paid or incurred for qualified research, including discovering information that is technological in nature. Its application must be intended for use in developing a new product or process, or improving an existing product or process. The research must include a process of experimentation to improve function, performance, reliability, quality or significantly reduce cost.

TCJA Impact

Before the Tax Cuts and Jobs Act (TCJA), taxpayers had a choice under IRC Section 174 when deducting R&D expenses. They could either expense all qualified expenditures in the year incurred, or amortize expenditures for up to five years. When the TCJA was passed, it removed the immediate expensing of R&D costs and required companies to amortize, beginning with tax years after Dec. 31, 2021. Now, R&D expenses are required to be amortized over five years for costs incurred within the U.S., or amortized over 15 years for costs incurred outside the U.S. Here’s an example with U.S. costs:

Expense Amortize
Costs $2,000,000 $2,000,000
R&D Tax Credit $100,000 $100,000
Net Costs $1,900,000 $380,000 ($1,900,000/5)
Tax Rate 21% 21%
Tax Savings $399,000 $79,800
R&D Tax Credit $100,000 $100,000
Total Tax Savings $499,000 $179,800

TCJA New Capitalization Rules

While Congress has made efforts to repeal or delay the amortization changes until 2026, no legislation has been passed just yet. Research credit rules are not impacted by the new capitalization rules, but the impact on taxable income and quarterly payments should still be considered. Further Section 174 expenses, including facilities costs or foreign research that does not qualify for the credit, should be reviewed for the new capitalization rules. In preparation, businesses should review their Section 174 expenses, as many companies have them but do not claim the research credit.

IRS-Required Information for Refunds of Valid R&D Credit Claims

For a taxpayer’s refund claim for the R&D tax credit to be valid, they must identify:

  1. All business components the research credit claim relates to for that year.
  2. All research activities performed for each business component.
  3. All individuals who performed each research activity for each business component.
  4. All the information each individual sought to discover for each business component.
  5. Total qualified employee wage expenses, total qualified supply expenses and total qualified contract research expenses.

To support these claims, taxpayers must provide a signed declaration stating the facts provided are accurate, under the penalty of perjury. Typically, a signature on Form 1040X or Form 1120X is sufficient. Taxpayers should provide the above claims in a written statement, versus a pile of documents. If documents are provided in lieu of a statement, however, taxpayers must state the exact page(s) supporting the specific facts. Loosely providing documents will not suffice to meet the taxpayer’s obligations. The IRS initially provided a grace period of Jan. 10, 2022. Since the grace period has passed, the IRS will have a one-year transition period allowing taxpayers 45 days to perfect the R&D credit claims prior to a final IRS determination on the claims. If you need assistance applying for the R&D refund claim, be sure to contact Doeren Mayhew’s Tax Incentives Group today.

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