IRS Guidance and Material – Swanson Reed | Specialist R&D Tax Advisors

IRS Guidance Anticipated in 2024 for R&D Amortization

The Internal Revenue Service has announced plans to issue draft regulations in early 2024 in an effort to address taxpayer questions on recent changes to research and development (R&D) amortization.

The guidance will address changes made by the 2017 Tax cuts and Jobs Act to Internal Revenue Code (IRC) Section 174 which governs the amortization of R&D expenditures. These changes removed any possibility of deducting R&D costs in full and instead required companies to amortize them over five years.

The anticipated guidance will build on a notice (Notice 2023-63) recently issued which stated the agency is working on regulations on how to amortize certain costs including software development and contracts. Additional guidance will explore foreign vs. domestic research.

In the September notice, the IRS asked for feedback on whether additional clarity is needed to better define specified research and experimental, or SRE, expenditures and how to properly allocate expenses to SRE activities or if safe harbors should be developed to address that issue.

Open questions also remain on whether there are more appropriate ways to define software development costs and if special considerations should be given to research conducted under contracts, including if special rules are needed for contracts involving foreign research, the notice said.

Taxpayers remain hopeful that these amortization requirements will be reversed. There are, as of now, two bills that have been introduced in an effort to reverse amortization requirements and support innovation in the nation. These include the bipartisan American Innovation and Jobs Act re-introduced by U.S. Senators Maggie Hassan (D-NH) and Todd Young (R-IN) and the American Innovation and R&D Competitiveness Act reintroduced by Reps. Ron Estes (R-Kansas) and John Larson (D-Connecticut).

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Swanson Reed regularly hosts free webinars and provides free IRS CE and CPE credits for CPAs. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.

IRS Releases Long Awaited Guidance on R&E Amortization

The IRS has released some long-awaited guidance (Notice 2023-63) to clarify the treatment of specified research and experimental expenditures (SRE) under Section 174. This guidance is specified as interim guidance, providing taxpayers with a small amount of guidance just days before the September 15 deadline. Those who are filing on extension or have been granted extensions for various catastrophic environmental conditions, or who regularly file on October 15 may find this guidance more useful as they will have a little more time to digest it.

The much-anticipated interim guidance, which taxpayers have the option of relying on immediately, addresses several issues, including:

The definition of software development
The treatment of research performed under contract
The identification and allocation of SRE expenditures
The interaction of Section 174 with long-term contracts under Section 460
Cost sharing arrangements under Section 482
Certain dispositions

The Treasury Department and the IRS intend to propose rules that will align with this interim guidance that would apply for taxable years ending after Sept. 8, 2023. Until then, taxpayers can rely on the interim guidance but are not yet required to implement the guidance provided. Taxpayers cannot rely only on certain sections while taking differing positions on other sections in the notice.

What is this guidance for?

The Tax Cuts and Jobs Act amended Section 174, removing the option to expense SRE expenditures and now require taxpayers to capitalize and amortize these expenses over a period of 5 years for domestic research and 15 years for foreign research, beginning with the midpoint of the taxable year in which the expenses are paid or incurred. This amendment also requires software development costs to be treated as SRE expenditures.

The amendments to Section 174 are applicable to SRE expenditures paid or incurred in taxable years beginning after Dec. 31, 2021. As provided by the TCJA, a change to implement the new Section 174 rules is a change in method of accounting that is applied on a cut-off basis.

Identification and Allocation of SRE Expenditures

The notice provides a description of SRE expenditures in section 4.02(2) and (3). This defines SRE expenditures to include expenditures that satisfy the requirements under the Treas. Reg. Sec. 1.174-2 or are incurred in connection with the development of any computer software – regardless of whether the software expenditures satisfy the Treas. Reg. Sec. 1.174-2 requirements.

The notice also includes examples of the types of costs that are considered incident to SRE activities, including but not limited to:

Labor costs
Materials and supplies costs
Cost recovery allowances
Patent costs
Certain operation and management costs (generally facility and equipment costs such as rent, utilities, insurance, taxes, repairs and maintenance costs, security costs, and similar overhead costs)
Travel costs

The notice also includes a list of costs that are not permitted or required to be treated as SRE expenditures. These include general and administrative costs, interest on debt to finance SRE activities, and amortization of amounts capitalized under Section 174 in prior years

Software Development

The notice also provides a few key definitions in Section 5.02(1) as it relates to software development. The definition of computer software is generally an expanded/updated definition of the ones found in Section 2 of Rev. Proc. 2000-50 and Treas. Reg. Sec. 1.197-2(c)(4)(iv). It includes cloud computing, updates, and enhancements. Upgrades and enhancements generally mean modifications to existing computer software that result in additional functionality (enabling the software to perform tasks that it was previously incapable of performing), or materially increase speed or efficiency of the software.

Section 5.03 of the notice provides a non-exhaustive list of activities that are treated as software development for Section 174 purposes:

Planning the development of computer software
Designing the computer software or upgrades and enhancements
Building a model of the computer software
Writing source code and converting to machine-readable code
Certain testing of the computer software until it is placed in service or ready for sale or licensing
Production of the product master(s) (for computer software developed for sale or licensing to others)

Work spent on general maintenance after software is placed in service (including debugging, denoising, and diagnosing the software), data conversion, and installation activities are generally not considered to be software development.

Research Performed Under Contract

Many have questioned how research under contract impacts amortization. The notice indicates that Research Recipients (i.e. the party that contracts a research provider) can reference Treas. Reg. Secs. 1.174-2(a)(10) and (b)(3) to determine if the costs paid are SRE expenditures.

For Research Providers, costs incurred are SRE expenditures if:

The research provider bears financial risk (i.e., risk that the research provider may suffer financial loss related to the failure of the research), or
The research provider has a right to use any resulting SRE product in its trade or business or otherwise exploit any resulting SRE product through sale, lease, or license.

When addressing long-term contracts, a percentage-of-completion (PCM) method should be used to account for income. Under the PCM, the portion of the contract price a taxpayer recognizes as revenue in a tax year corresponds to the ratio of incurred allocable contract costs to total estimated allocable contract costs. The regulations further provide that taxpayers deduct allocable contract costs as they are incurred and, as provided by Treas. Reg. Sec. 1.460-4(b)(2)(iv), an increase in the percentage of the contract price to be reported is matched by deduction of the incurred costs that cause the increase. The government stated in the notice that “the current Section 460 regulations provide that incurred research or experimental expenses increase the percentage of the contract price required to be reported, although Section 174(a) prevents a corresponding current deduction of incurred SRE expenditures.”

The notice provides further information on short taxable years, cost sharing, and the retirement or abandonment of property related to SRE.

The IRS is requesting any comments or questions requiring further guidance or clarification to ensure the provided information covers all bases.

While this notice does provide some helpful clarity in the forthcoming proposed regulations, the timing of the notice’s release was truly not ideal. Many taxpayers have already filed their returns for their first taxable year beginning after December 31, 2021. Those that have yet to file are left with little time to analyze the guidance and potentially change their accounting methods. Regardless, if taxpayers adhere to the guidance, the notice requires the implementation of all rules. There is no cherry picking here.

Taxpayers that do not intend to implement the guidance provided in Notice 2023-63 for their 2022 tax return should begin to evaluate how their 2022 computations and positions align with the guidance in the notice to ensure they are better prepared to implement the guidance in the anticipated proposed regulations, which the notice says is expected to be applicable for the first taxable year beginning after Sept. 8, 2023. However, proposed regulations are generally not applicable until finalized, so it’s unclear whether the government meant to refer to the final regulations. The notice contains a long list of areas in which the government specifically is requesting comments, so the government may make some changes to these proposed rules based on those comments.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

IRS Guidance on Amending Returns for R&D Tax Credit

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The IRS issued a Chief Counsel memo in fall 2021 outlining specific information now required when amending a tax return to include the R&D tax credit. This supplemental information will be used to aid the IRS in expediting their review process of amended returns.

This new requirement for supplemental information impacts any taxpayer planning to amend their tax return for an R&D tax credit after January 10, 2022. If the IRS finds the information provided deficient, the credit claim could be denied.

Previously, amended returns were treated similarly to timely filed returns, wherein taxpayers would only need to provide supplemental documentation upon request.

The supplemental documentation is to be included in the amended tax return to be reviewed by an IRS agent upon submission. If the claim were to be found deficient, the return would be denied. The taxpayer would then have 45 days to perfect the claim and resubmit it to the IRS.

What is a Valid Tax Credit Claim?

In order to be a valid claim, as defined by the IRS, Taxpayers must:

Identify all the business components to which the Internal Revenue Code (IRC) Section 41 research credit claim relates for that year.
Identify all research activities performed for each business component.
Name the individuals who performed each research activity.
Describe the information each individual sought to discover.
Provide the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year. This may be done using Form 6765, Credit for Increasing Research Activities.

Additional Details and FAQs

Transition Period

- - The IRS extended the transition period to January 10, 2024. During the transition period, taxpayers who file an amended tax return for an R&D credit claim will be allowed 45 days to perfect their claim if the IRS finds the initial filing deficient.
  - After this transition period closes, credit claims that are denied can’t be fixed or appealed.
  - Taxpayers will not receive any refunds for the credits they attempted to amend.

What is “Perfecting a Claim for Refund?”

- - Perfecting a claim means taxpayers have the opportunity to provide missing information to process the R&D credit claim.
  - The IRS will notify taxpayers of a deficient claim and provide a maximum of 45 days to perfect the claim. The letter sent to the taxpayer will include the date by which the taxpayer must provide the updated claim.

Does supplementary documentation need to be submitted if a claim isn’t being amended for a refund?

- - No. If an R&D credit is submitted on an amended tax return that doesn’t result in a refund to the taxpayer, the supplementary documentation for the claim doesn’t need to be submitted with the amended tax return.

What’s the preferred method to provide missing information to the IRS?

- - The IRS noted that the best way to provide missing information for a deficient claim is by fax to a designated number. You can also send information by mail.
  - As of publication date, the IRS planned to have amended tax returns with R&D credit claims reviewed and processed within six months of receiving the amended tax return.

Pass through entities

- - If a claim for refund that includes the Research Credit is based on a Research Credit from a BBA partnership, the BBA partnership does not file an amended return. Instead, the BBA partnership must file an administrative adjustment request (AAR) and attach the five items of information to that AAR. As part of the AAR process, the BBA partnership will also submit Forms 8985 and 8986 to the IRS and send Forms 8986 to its partners. The BBA partnership is not required to provide the five items of information again on the Forms 8985 and Forms 8986. The BBA partners do not need to attach the five items of information to their original returns to which their Forms 8986 are attached.
  - If a claim for refund that includes the Research Credit is based on a Research Credit from a non-BBA pass-through entity (such as a TEFRA partnership, S corporation, or other non-TEFRA/non-BBA partnership), the non-BBA pass-through entity may include the five items of information with its amended return. Partners or shareholders are required to include the five items of information with their amended tax return claiming the Research Credit. Partners or shareholders should receive the five items of information from the partnership or S corporation in which they are a partner or shareholder, for example, in the form of an amended Schedule K-1 (and any statements attached thereto).

What if you e-file an amended return?

- - Taxpayers who e-file their amended return claiming a refund involving the R&D tax credit are still required to provide the five items of information with their e-filed amended tax return.

Statistical Sampling

- Revenue Procedure 2011-42 provides guidance to taxpayers on using statistical sampling.
- If taxpayers utilize a statistical sample to compute their Research Credit, the documentation for all units in the sample must contain the first four items of information and must be provided with the claim for refund.
- Taxpayers utilizing a statistical sample to compute their Research Credit are still required to provide the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses, as computed pursuant to Rev. Proc. 2011-42, for the claim year with the claim for refund.

Additional questions have been answered in an FAQ released by the IRS.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

ERC and 2021 R&D Credits

Rhode Island Patent of the Month - December 2021

The IRS has released information and updates surrounding the impact of the Employee Retention Credit (ERC) on the R&D credit for the 2021 financial year. Through an announcement and then an updated instruction set for the R&D tax form 6765, we can see that the IRS has decided companies can benefit from one or the other tax credit.

Previous Rule

The 2020 Tax Year allowed a company to claim both the ERC and R&D tax credit from the same employee wages.

New Rule

The Consolidated Appropriations Act (CAA) went into effect on December 27, 2020. Based on more recent notices in the past month from the IRS, this act has solidified that a company can no longer use the same wages to claim both the ERC and R&D Credits for 2021.

This means, if you claimed ERC for wages for an employee involved in R&D, this claimed amount cannot be factored into the R&D credit calculation.

The introduction of COVID-19 stimulus measures has added to the complexity and intricacy of the U.S. tax code. Understanding how each stimulus interacts with the R&D credit is crucial to filing a complete and accurate claim.

Are you conducting research and development activities? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

Who We Are:

Swanson Reed is one of the U.S.’ largest Specialist R&D tax advisory firms. We manage all facets of the R&D tax credit program, from claim preparation and audit compliance to claim disputes.

Four Things You Need to Know About the IRS Directive for LB&I Taxpayers

On September 11, 2017, the Internal Revenue Service (IRS) issued a new directive for Large Business & International (LB&I) taxpayers. The purpose of the directive is to make determining the amounts of Qualified Research Expenses (QREs) when filing for the R&D Tax Credit more efficient while also reducing the burden on LB&I taxpayers and examiners in determining those amounts. The new directive for LB&I taxpayers provides a “safe harbor”.

1. Under what conditions can this directive apply?

There are two main conditions:

The directive applies to LB&I taxpayers, namely taxpayer’s assets must amount to at least $10 million
The LB&I taxpayer’s certified financial statements must be in accordance with the Adjusted Accounting Standards Codification (ASC) 730

2. How does this directive make the process more efficient?

The definitions for QREs outlined in section 41 of the IRS, which comprises the R&D Tax Credit, do not always match the definitions of financial accounts. In common practice, LB&I taxpayers often go through a time-consuming process where different employees need to be contacted in order to determine the QRE amounts. In contrast, the new directive for LB&I taxpayers allows taxpayers to determine the QREs already on the financials and then adjust those amounts. While the adjustment process is still rigorous, this would nevertheless reduce the burden of determining QRE amounts.

3. Are there limits to the directive?

Yes. For one, the directive can only be used for current year QREs. The directive does not apply to research conducted under contract and contractor costs. Applying the directive also requires reducing wage costs. Thus, the directive for LB&I taxpayers may not be advantageous for all.

4. Is this official law?

No. The IRS clearly outlines that the directive “is not an official pronouncement of law, and cannot be used, cited, or relied on as such. In addition, nothing in the directive should be construed as affecting the operation of any other provision of the Internal Revenue Code, Treasury regulations or guidance thereunder.”

Need more information?

With its expertise and experience in the R&D Tax credit, Swanson Reed can help you navigate the changes with the IRS’ new directive for LB&I taxpayers. To find out more, please contact a Swanson Reed R&D Specialist today.

Swanson Reed regularly hosts free webinars and provides free IRS CE credits as well as CPE credits for CPA’s. For more information please visit us at www.swansonreed.com/webinars or contact your usual Swanson Reed representative.

irs R&D tax credit

PATH Act of 2015: The Payroll Tax Offset

The PATH Act of 2015

What is the Payroll Tax Offset?

With the passing of the PATH ACT of 2015, the Research & Development Tax Credit has finally become a permanent fixture of the U.S. tax code, but more notably, the legislation makes a key enhancement that will significantly benefit many start-ups and small to mid-sized businesses. The legislation allows qualified small businesses to apply credits in excess of income taxes to FICA taxes. This is especially beneficial to companies that were unprofitable and have no income taxes. The PATH Act will generate a cash flow for unprofitable businesses where one did not previously exist.

The Payroll Tax Offset:

Allows a payroll tax offset for start-up businesses (under $5 million in gross receipts)
These companies can take a credit against FICA taxes only
Maximum credit is capped at $250,000 per year for five years
Effective for January 1, 2016, but not available for 2015 or earlier periods

Tell me more…

Qualified companies can now take a credit against the employer’s portion of Federal Insurance Contributions Act ‘FICA’ taxes. The FICA tax is a Federal tax on gross salaries to fund the Social Security and Medicare programs. While it is levied on both employers and employees, only the employer portion will be subject to offset R&D credits in excess of income taxes. The IRS has not yet indicated whether they will allow offset against both pieces of the FICA tax (Social Security and Medicare) or just one. Companies should keep their Form 941’s available so that the appropriate taxes can be extracted.

What is a “Qualified Small Business?”

A “Qualified Small Business” is described as a business with under $5 million in annual gross receipts and has generated gross receipts for no more than five years. Hence, the PATH Act is particularly valuable for start-up companies with R&D expenses but no taxable income. Since no-profit companies have no income taxes to offset, the R&D credit can be applied directly to its FICA taxes, thereby benefitting the company regardless of its no-profit situation.

Is there a limit on how much I can claim?

Yes, there is a maximum credit capped at $250,000 per each eligible year for five years. The IRS has not yet indicated whether the payroll tax deduction line (taxes and licenses) will be reduced while another line increases by the same amount for the credit. That will likely be the case, though, and a credit is always more beneficial than a deduction. Furthermore, any unused credit may be carried forward to offset against future payroll tax liabilities.

Can I apply this new rule to previous tax years?

Unfortunately, the payroll tax offset cannot be applied to any years previous to tax year 2016.

EXAMPLES of how the Payroll Tax Offset works

Example 1

DEVO, a small tech company founded in 2014, had acquired substantial R&D and payroll expenses in tax year 2015, however no revenue was produced. Since it worked at a loss, DEVO did not claim any R&D Tax Credit in 2015. Moreover, the small company expects 2016’s activities to be comparable with those of 2015.

DEVO’s 2016 Activity

Business Form of the Taxpayer	C-Corporation
R&D Tax Credit Eligibility	$150,000
Payroll Tax Liability	$100,000

Because of the PATH Act, DEVO should secure the $150,000 of R&D Tax Credit in 2016 and elect to offset it against the $100,000 of payroll tax liability and carry forward the remaining $50,000 to offset against future payroll tax liability.

Example 2

DEVO’s 2017 Activity

Business Form of the Taxpayer	C-Corporation
R&D Tax Credit Eligibility	$200,000
Income Taxes	$100,000
Payroll Tax Liability	$150,000

In 2017, DEVO started to make a profit. DEVO will apply their $200,000 R&D Tax Credit against their income taxes, leaving $100,000 of the credit remaining. Under the PATH ACT, this remaining credit will be used to offset $100,000 of their $150,000 payroll tax liability.

View the PDF version of this post.

How the New AMT Tax Offset Impacts Small Businesses

Undeniably, the permanency of the Research and Development (R&D) Tax Credit is a game changer for start-ups and small businesses. The newly revamped R&D Tax Credit program, as enacted through the PATH Act, now permits eligible small businesses to claim the credit against the Alternative Minimum Tax (“AMT”) for tax years commencing after December 31, 2015.

Indeed, small to mid -sized business owners are all too familiar with the prodigious “gotcha” called AMT. AMT has a tendency to limit the usage and effectiveness of particular tax deductions and credits. Originally, it was intended to increase taxpayers minimum tax paid in certain instances. Historically, the R&D tax credit had limited worth if a taxpayer was subject to the AMT and it was one of the greatest barriers for small businesses.

However, starting 2016, businesses (and business owners) with less than $50 Million in gross receipts can now offset their AMT tax liability with R&D tax credits.

Thus, this AMT modification facilitates small business owners who are currently subject to AMT to actually utilize the benefit of the R&D Tax Credit. Therefore, they can then use these tax savings to reinvest the saved tax dollars back into their businesses to strengthen R&D efforts and cultivate their companies. Moreover, the amended R&D tax credit allows qualified start-ups to use the credit to offset the employer share of FICA taxes (as we have discussed in Clarifying the New Payroll Tax Offset & An Example of How the New Payroll Tax Offset Works).

Ultimately, the enhanced capability for more small businesses to use the R&D credit should result in an economic boost to many taxpayers. Start-ups, in particular, can now enjoy current cash benefits rather than having to wait until their companies produce taxable income to take advantage of the credit savings.

It is imperative, however, that businesses recognize what kinds of costs are eligible in order to maximize the credit so that appropriate records can be sustained throughout the year. Swanson Reed’s R&D tax professionals are available to discuss the R&D tax credit and the changes in the new PATH Act – contact us today if you would like to know if your company now qualifies.

An Example of How the New Payroll Tax Offset Works

The ‘elixir of economic growth’, whilst sounding like a surreptitious tincture crafted by an alchemist, is actually frequently assumed by economists to be relating to research and development (R&D). Thanks to the PATH Act being passed in December, the United States observed the Federal R&D Tax Credit finally convert to permanent. Now, start-ups and small companies may be eligible for generous tax savings allowing them to also reap the benefits of R&D.

In our last post we clarified the particulars of the new Payroll Tax Offset legislation and how that impacts an R&D claim. But just how much of an influence will this legislation have on a single company?

Start-ups, in particular, will likely benefit the most as the changes have made the credit more accessible to smaller ventures. Essentially, the new ruling allows for fledgling companies to claim the credit against their payroll taxes, presuming that the employees are engaged in research and development.

An example of how the new Payroll Tax Offset has been provided below to clarify how this impacts a start-up company.

A start-up hires three people whose activities are 100% dedicated on qualifying R&D. Each one makes $60,000 a year. In this example, the start-up would save a total of $11,160 per year – 6.2% of their collective salaries. However, the R&D tax credit would only offset half that amount if they only spent half their time on R&D.

Moreover, what is suitable as “qualified R&D activities” doesn’t need to pertain to rocket science. Your start-up may be eligible if it is working to develop new and improved products; is facing technical uncertainty; the work is technological in nature; and it involves a process of experimentation. Fundamentally, the changes in the R&D tax credit could now allow young companies to save thousands of dollars.

If you want to get the Payroll Tax Offset, and avoid IRS inspection, you may wish to contact a qualified R&D tax specialist, such as Swanson Reed. In addition, you will need to properly document your R&D projects as soon as they start. Read our blog on ‘How to make the most of your R&D Tax Credit Claim’ to discover more about the documentation needed.

Contact Swanson Reed for more information on how we can advance your company’s market value and boost its bottom line through the Research and Development Tax Credit.

Clarifying the New Payroll Tax Offset

A highlight of 2015 for research and development (R&D) was the passing of The Protecting Americans from Tax Hikes (“PATH”) Act of 2015, which saw the R&D Tax Incentive become permanent. Essentially, taxpayers that couldn’t utilize or take full advantage of the tax credits in the past should now reassess their eligibility and possibly take advantage of this lucrative incentive.

However, there are a lot of questions surrounding the new rules of the permanent R&D Tax Credit, in particular, the new payroll tax offset.

Previously, start-ups that qualified for the federal R&D tax credit but weren’t yet paying taxes had the option to carry forward the credit to use in later years when they did have a tax liability. However, the new R&D tax credit now allows qualified small businesses to elect to use a portion of their R&D tax credit now to offset payroll taxes, instead of waiting to use the credit. This is essentially what the Payroll Tax Offset is.

In Summary, the Payroll Tax Offset:

Allows a payroll tax offset for start-up businesses (under $5 million in gross receipts). These companies can take a credit against FICA taxes only – other payroll taxes are excluded.
Maximum credit was originally capped at up to $250,000 per year for up to five years. However, The Inflation Reduction Act of 2022 increased this limit to $500,000 for tax years beginning after December 31, 2022, for qualified research activities.
Effective for taxable years beginning after December 31, 2015. The payroll tax offset election must be made on a timely filed entity tax return. You cannot amend a tax return to elect the payroll tax offset.

To elucidate the above, these companies can now take a credit against the employer’s portion of FICA taxes (6.2%).

The FICA tax is the Federal Insurance Contributions Act tax and is a United States federal payroll (or employment) tax imposed on both employees and employers to fund Social Security and Medicare. However, the Payroll Tax Offset only encompasses FICA taxes, other payroll taxes are omitted.

Changes Introduced by The Inflation Reduction Act of 2022:

Starting in the first quarter of 2023, the payroll tax credit is first used to reduce the employer share of social security tax up to $500,000 per quarter. If any credit remains after reducing the employer share of social security tax, the remaining amount then reduces the employer share of Medicare tax for the quarter.

Any remaining credit, after reducing both the employer share of social security tax and the employer share of Medicare tax, is then carried forward to the next quarter.

This enhancement significantly increases the benefit for eligible small businesses, allowing them to maximize the credit’s impact on their payroll tax obligations.

Additional Details:

The maximum credit is now capped at $500,000 per year, a substantial increase from the previous $250,000 limit, making the credit even more valuable for small businesses engaging in qualified research activities.
The payroll tax offset continues to be effective for taxable years beginning after December 31, 2015, but remains unavailable for 2015 or earlier periods.
It is important to note that the total of payroll tax credit claimed does not decrease the amount of deductions permitted for payroll taxes on the tax returns. Furthermore, any unused credit may be carried forward to offset against future payroll tax liabilities.

Definition of a Qualified Small Business:

A “Qualified Small Business” is described as a business with under $5 million in annual gross receipts and has no gross receipts exceeding five years. Hence, this is particularly valuable for start-up companies, who, the majority of the time, will produce R&D expenses but won’t have a taxable income and aren’t paying federal income taxes.

Case Study Example:

A small company was founded in 2015. It had acquired substantial R&D and payroll expenses; however, no revenue was produced. Since it worked at a loss, the small company did not chase any R&D Tax Credit in 2015.

Moreover, the small company expects 2023’s activities to be comparable with a payroll tax liability of $200,000 and will be eligible for $300,000 of R&D Tax Credit. Due to the new Inflation Reduction Act of 2022, the small company should secure the $300,000 of R&D Tax Credit in 2023. It can elect to offset it against the $200,000 of payroll tax liability (first against social security tax, then Medicare tax), and carry forward the remaining $100,000 to offset against future payroll tax liability.

Importance for Businesses:

Bear in mind that the R&D Tax Credit incorporates a diversity of activities (both basic and applied research) and also various industries. Consequently, it is important that business owners involve the assistance of professionals to decide not only the businesses’ eligibility for R&D Tax Credit but also which R&D activities qualify.

Swanson Reed is a specialist R&D tax credit firm that offers expertise across a wide assortment of industries and has helped many clients achieve tax cash savings under the R&D tax credit scheme. Contact us today to find out more.

How to Prepare for an R&D Tax Credit Audit

New rules and regulations have made it easier for all types of businesses to profit from the R&D Tax Credit, but there is always a possibility that the credit will provoke an IRS audit. Even hearing the word audit can make someone’s head spin, so it’s best to be as prepared as possible to help ease your mind. Here are a few tips that will help one prepare for an R&D tax credit audit.

Collect and Organize your Documentation

Documentation is the basis of the R&D Tax Credit, so having your records organized and readily available is essential. Appoint a staff member who has access to the documents to collect the data throughout the R&D project. That way one person will be responsible for having everything in once place in case an audit occurs. Read up on what documents are needed to claim.

Get Familiar with the Audit Techniques Guides

The Audit Techniques Guides are published by the IRS to train IRS employees, but are available to the public to help provide a better understanding of the audit process. There is a large assortment of guides, each one tailored to a specific audit concern. There are four different ones for the R&D Tax Credit alone that can be found on the Research Credit page of the IRS website. Be aware that some guides are industry specific so make sure to choose the one tailored to your business. Even skimming one will help prepare you for what to expect.

Consult a Specialist

Getting advice from your tax preparer is always a good thing, but the R&D Tax Credit may be outside of their normal practice. If you do claim the credit it will be beneficial to consult with an R&D Tax Credit specialist. They will help determine your eligibility, properly prepare your claim up to IRS standards and provide guidance in the case of an audit. Click here for more information about Swanson Reed’s technical expertise.

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