The federal research and development (R&D) tax credit has undergone several changes in the past few years. Changing the rules allows credits to offset payroll or against alternative minimum tax (AMT) is no longer a federal tax incentive for large Texas companies. The R&D credit is more accessible than ever, opening the door to significant savings for many small to mid-sized companies across several industries.
Despite this, new requirements for claiming the 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 2023, the traditional 45-day grace period is going away, and incomplete or incorrect documentation submissions will render a refund claim void. 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 R&D Refund Claims for Amended Returns
Starting in 2022, new submission requirements for the R&D credit refund are in effect. To date, new documentation rules only apply to amended returns.
The five items that must now be included in amended filings include:
- Information on business components – This is 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.” Taxpayers must have sought a new or improved function, performance, process, or quality of a specified business component related to the project’s purpose.
- Eligible research activities – To determine eligible activities, it is vital to refer to the four-part test. Any eligible activity must meet all the following:
- The activity must have a clear and defined purpose.
- It must seek to eliminate the uncertainty.
- Be technological in nature.
- The activity must have followed a process of experimentation.
- Individuals involved – The new regulations require that all individuals involved in the research must be documented and separated by business component. It is important to note that individuals must be listed by title or position, and the total number involved will also need to be disclosed. Finally, full names are generally not required, but the IRS reserves the right to ask for that information in a more substantive review.
- Information targeted – The taxpayer must also provide a list of the information each individual on the project sought to uncover.
- Total wages/expenses – Taxpayers must also submit information on the total wages and outside contractor expenses incurred. It is important to remember that employee wages and contractor expenses should be listed separately. Management wages are ineligible and can not be claimed.
It’s a good idea to keep all documents for at least three years, though the IRS 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. More documentation upfront is meant to alleviate the extra workload of reviewing claims. Still, the expedited review process can take up to six months.
Filing New R&D Credit Claims
New R&D credit claims aren’t subject to the additional documentation requirements contained in the five information items. 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 documentation includes payroll records, job descriptions, contracts, 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 Credit in 2022
Two other changes to the R&D credit in 2022 both restrict and expand its use.
Taxpayers can no longer take their full R&D credits in a single year. The credits must be amortized over five years instead. This will decrease the credit’s value in the short term, but it remains one of the businesses most valuable tax incentives.
Second, the Inflation Reduction Act expanded the payroll provision. Now, companies can claim a refund worth up to $500,000 against the employer’s portion of payroll taxes. This is double the previous amount. To claim the R&D credit against payroll taxes, the taxpayer must not have had more than $5 million in gross receipts for the tax year(s) applicable to the credit and be less than five years old.
So, while the payroll provision has been expanded, the new documentation rules may discourage smaller businesses from applying for an R&D credit refund.
Since 2022 has been the first year of implementing these new rules, taxpayers have had a 45-day grace period to correct missing or incomplete information. Starting January 9, 2023, that’s no longer the case. Next year, incorrect R&D refund documentation will mean an automatic denial. Therefore, taxpayers who may want the grace period to ensure their claim is accurate should file an amended return as soon as possible.
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 form below.