The federal Research & Development (R&D) tax credit has been an essential tool in providing financial support to businesses invested in innovation. It offers important support to those involved in one-time projects or long-term R&D activities. Since eligible expenses can be immediately deducted many are able to realize immediate savings making the credit quite popular. In fact, over the last 18 years the number of businesses claiming the credit has doubled reaching over 26,000 in 2018.
Unfortunately, a modification to the credit passed as part of the Tax Cuts and Jobs Act has significantly changed how savings are claimed. Starting in 2022, taxpayers are now required to capitalize and amortize expenses over several years. Due to concern about how businesses will be impacted, the American Jobs and Investment Act (Act) was recently introduced in Congress. The legislation calls for a change to restore the immediate deduction feature under IRC Section 174 (§174) as well as other updates. To help clients, prospects, and others, JLK Rosenberger has provided a summary of the key details below.
Proposed Changes – American Innovation & Jobs Act
- Eliminates the 174 Amortization Requirement – The Act calls for the removal of the amortization requirement starting in the tax year 2022 and would make the modification permanent. In addition, the change would be a retroactive fix effective January 1, 2022.
- Payroll Tax Offset Increase – Previously, the R&D credit could be used to offset payroll of $250k for up to 5 years. The Inflation Reduction Act raised the limit to $500k for up to 5 years. The Act proposes to increase offset in increments of $25K starting in 2024 and ending in 2033 resulting in an offset of $750k. If passed, this means the offset would be $250k in 2022, $500k in 2024, increasing by $25K each year and ending with a $750k offset in 2033.
- Qualified Small Business Eligibility Expanded – Under current regulations, there are two criteria that must be satisfied to be considered a Qualified Small Business (QSB). This includes no prior gross receipts for any taxable year over the lookback period of five years, and have less than $5M in gross receipts as determined under Section 448(c)(3). The Act would change this to a gross receipts limit of $15M or less and extends the no prior gross receipts requirement to 8 years. In addition, it would also change the zero gross receipts requirement to $25k or less. This change would be a huge win. Under the new provision, a company that had no box 1c gross receipts, but had 1000 dollars in other (rental, investment, etc.) income that would have been eliminated, will still be eligible.
- Calculation Changes for Start-Ups – The Act changes the credit calculation to increase the percentage from 14% to 20% used under the ASC calculation method. In addition, for companies that do not have any expenses in the past three years, instead of using 6% of current year expenses in credit calculation, the change would increase it to 10% for QSBs.
- Reasonableness Requirement Reinstated – There would be a reasonableness requirement that 174 expenses must meet. IRS guidance requires that claimed expenses need to be reasonable amounts and clearly identify expenses that are not (IRC Section 1.174-2). Dividends, gifts, loans and similar payments. IRS Memo 20154501F guides that total compensation, including taxable, non-taxable, and deferred compensation, was relevant in determining the “reasonableness” of the amount.
The American Innovation and Jobs Act provides several changes designed to provide immediate relief to businesses claiming the R&D tax credit. Although the legislation is still under consideration, it does provide important insight into potential changes coming. If you have questions about the information outlined above or need assistance with an R&D tax credit study, JLK Rosenberger can help. For additional information call 94-860-9902 or click here to contact us. We look forward to speaking with you soon.