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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.
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.
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:
|R&D Tax Credit||$100,000||$100,000|
|Net Costs||$1,900,000||$380,000 ($1,900,000/5)|
|R&D Tax Credit||$100,000||$100,000|
|Total Tax Savings||$499,000||$179,800|
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.
For a taxpayer’s refund claim for the R&D tax credit to be valid, they must identify:
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.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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