The federal Research and Development (R&D) tax credit has undergone several changes in the past year. By expanding the allowable research credit amounts to offset payroll tax, it is no longer a federal tax incentive reserved for large Texas companies. In fact, the R&D tax credit is more accessible than ever, opening the door to significant savings for many small to mid-sized companies across several industries.
Additionally, new requirements for claiming the research credit on amended returns can trip up taxpayers – even those who have previously filed. This complicates matters, especially for those who want to file an amended return to claim a past credit.
Starting in January 2024, the traditional 45-day grace period is going away, and submissions with incomplete or incorrect documentation will render a refund claim void. This means taxpayers must pay careful attention to the new submission requirements to ensure compliance. To help clients, prospects, and others, Calvetti Ferguson has provided a summary of the key details below.
New Refund Claim Requirements for Amended Returns
Starting in 2022, new submission requirements for R&D tax credit refunds are in effect, which only applies to amended returns where taxpayers are making a refund claim. For a taxpayer’s refund claim for the research credit to be valid, the taxpayer must:
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- Identify all the business components to which the Section 41 research credit claim relates for that year. Business components are defined as “any product, process, computer software, technique, formula, or invention which is to be held for sale, lease, or license, or used by the taxpayer in a trade or business of the taxpayer.”
- For each business component
- Identify all research activities performed;
- Identify the individuals involved in qualified research activities; and
- Identify the information sought to discover, develop, or improve.
- Total Wages/Expenses – Taxpayers must also provide the total qualified employee wage expenses, total qualified supply expenses, total qualified contract research expenses, and total computer leasing costs for the claim year. This may be done using Form 6765, Credit for Increasing Research Activities.
It is a best practice to keep all documents for at least three years, though the IRS generally recommends six. The IRS implemented these changes to help make the review process quicker and more streamlined. For years, IRS agents had to conduct manual reviews for refund claims that were missing critical information. Requiring more documentation upfront is meant to alleviate the extra workload of reviewing claims. Still, the expedited review process can take up to six months.
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- Filing New R&D Credit Claims – R&D tax credit claims filed on originally filed returns are not subject to the additional documentation requirements contained in the five items of information. Instead, they should follow the same reporting rules that taxpayers have been used to. These include original receipts, invoices, and project billings for all expenses.
Other pieces of documentation include payroll records, job descriptions, contracts, business component descriptions, project notes and meeting minutes, 1099 forms, and more. Pre-tax deductions need to be deducted from employee wages.
Other Changes to the R&D Tax Credit in 2022
Two other changes to the research and experimentation expenditures and research credit start for tax years beginning after December 31, 2021, which both restrict and expand its use.
1. Amortization of Research and Experimentation Expenditures
With the passing of the Tax Cuts and Job Act of 2017, for tax years beginning after December 31, 2021, §174 R&D expenditures are required to be capitalized and amortized over five years. Historically, these §174 R&D expenditures could be expensed in the year incurred, thus lowering the taxable income.
2. Expansion of Payroll Tax Credit Benefit
Second, for tax years beginning after December 31, 2022, the Inflation Reduction Act expanded the payroll provision to allow eligible small businesses to claim a refund worth up to $500,000 against the employer’s Medicare portion of payroll taxes, which is double the previous amount. To claim the R&D credit against payroll taxes, an eligible small business must have had less than $5 million in revenue and revenue for less than five years. The payroll tax offset can be utilized on original and timely filed returns only and can be utilized in the quarter after which the research credit claim is filed.
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Even though the documentation required to file an amended return has increased, the R&D tax credit is still one of the best tax credits offered. If you have questions about the information outlined above or need assistance with claiming the R&D tax credit, Calvetti Ferguson can help. For additional information, please fill out the contact form below. We always look forward to speaking with you.