Companies that engage in research and development can reap rewards in the form of tax credits. How credits and deductions can be claimed vary for state R&D deductions/credits. Federal deductions are more uniform but they can be complex. What qualifies as research? What expenditures count?  There are a variety of interpretations that may apply to your business.

We are going to focus on IRC Sec 174,  IRC Sec 41, and IRC Sec 280, highlighting some salient points. 

Section 41 is an R&D tax credit that is calculated in one of two ways: these are the regular research credit calculation or the alternative simplified method. The first of these is more complex while the second, as the name suggests, is simpler. For the regular research credit (RRC) a company has to average gross R&D receipts for the previous four years. There are also additional requirements for companies based on when the business began operating.

The second method, Accounting Standards Codification (ASC), does not require the gross receipts to be calculated, instead looking at the qualified research expenses for the previous three years. The RRC method can be a problem if your business doesn’t have long-term records lying about.

Section 174 deals with amortization of R&D expenses. Beginning in 2022, businesses were required to both capitalize R&D expenses during the year and amortize them over a five-year period for U.S.A research (15 years for research done abroad). As described in our earlier blog the research expense has to come about in the taxpayer’s business and must refer to experimental activity. If you conduct the experimentation in a laboratory? That qualifies. In some cases what might seem like “experimentation” to a business owner does not qualify. The type and aim of the experimentation matters. Is the aim a new technology or process? This is one of the reasons you want professional help claiming R&D credits. 

Then there is section 280C (c) and changes made six years ago. Section 280C(c)  essentially aims to prevent businesses from being able to receive a deduction and a credit for the same amount. This is a simplification, of course, because there is always complexity when it comes to taxation. 

The Tax Cuts and Jobs Act (2017) amended the laws there is some ambiguity. In a specific year where the taxpayer’s R&D credit, under section 41, is less than what is allowed as a deduction for qualified research expenses (QRE) does the taxpayer need to adjust their income under this section 280C? Before the TCJA the answer was likely, yes. Now it may be no. There is even a question if the research credit exceeds the allowed amount. How much is the reduction amount?

Another complexity is added depending on the state where you file your taxes. States also may offer their own R&D tax credits. Most states follow the IRS interpretation of what a QRE is but not always.  When it comes to business taxes there is often a “not always” qualification attached to any statement. California, for instance, defines “gross receipts” differently. The state does not include rent, interest, or service-related expenses. Only actual, for sale, property counts! Of course, this refers to both tangible and intangible products sold and delivered in the state. Other states have their own, sometimes minor, divergences. 

Hito is ready to help you through the rapids of claiming the R&D credit. We are a click away