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Many companies that focus on innovation were required to make a significant change when claiming the federal Research and Development (R&D) tax credit last year. The change requires a company with eligible expenses under IRC Section 174 to amortize and capitalize expenses over a 5 year period for domestic and 15 years for international expenses. There is an extender’s bill likely on the way that would repeal this requirement until tax year 2026. This would return prior legislation allowing taxpayers to take an immediate deduction of research expenditures in the year claimed.
Earlier this month, the IRS issued Notice 2024-12 which provides additional guidance for those claiming 174 R&D expenses. The Notice serves as an update to the information provided in Notice 2023-63 and addresses certain open-ended questions about contracted and specified research and experimental (SRE) amounts that can be claimed from a tax perspective. Since it is expected the guidance will be finalized this year, it means taxpayers may soon be required to follow it for tax return compliance in claiming these costs. To help clients, prospects, and others maximize the benefits under Section 174, JLK Rosenberger has provided a summary of the key details below.
What is an SRE product?
Section 174 defines a specified research expenditure (SRE) as “any pilot model, process, formula, invention, technique, patent, computer software, or similar property (or a component thereof) that is subject to protection under applicable domestic or foreign law.”
Contracted Research Expenses:
Identifying the “Research Provider” and “Research Recipient”:
- Research Recipient: the recipient of the research services provided by an outside party
- Research Provider: the contracting party that is providing research services or a SRE product to the Research Recipient
Who Claims the 174 Expense?
You need to look at two factors or a two-part test:
- Does the taxpayer claiming the expense have Rights in the Research?
- Does the taxpayer claiming the expense have Financial Risk in the Research?
Rights to the Research:
This hinges on whether the Research Provider has a right to use the SRE product developed in its trade or business or exploit it through sale, lease, or license. If so, the Research Provider may have rights to the SRE product.
If the right to use the SRE product is conditioned on approval from the contracting party or an unrelated party to the agreement, then the Research Provider does not have rights to the SRE developed under the contract.
Also, it cannot be an excluded SRE product right. Excluded SRE Product Rights for the Research Recipients is defined as a right that is:
- separately bargained for or not included in the cost paid by the research provider to perform the research activities under the contract;
- acquired for the limited purpose of carrying out the research activities under the contract, such as background IP clauses or licenses granted by the Research Recipient to the Research Provider to allow for the development of an SRE product; or
- other know-how not subject to legal protection.
The information contained in the recently issued IRS Notice provides important information taxpayers need to consider when claiming eligible expenses. If you have questions about the information outlined above or need assistance claiming the federal R&D tax credit, JLK Rosenberger can help. For additional information, call 949-860-9208 or click here to contact us. We look forward to speaking with you soon.