November 15, 2021
The Research & Development (R&D) tax credit helps Atlanta and Georgia companies offset the cost of qualifying research and experimental activities with a dollar-for-dollar federal credit worth anywhere between 6 and 20 percent, depending on the calculation method and circumstances. It is a valuable tax planning tool that reduces federal income tax liability, improves cash flow, and encourages further investment in technological advances. Each year, the IRS reviews thousands of R&D tax credit claims worth millions of dollars. It is an arduous process that takes a substantial amount of time. This fall, the IRS has revised the process for claiming the research tax credit in the recently issued IRS Office of Chief Counsel Memorandum 20214101F. Under the new guidance, business taxpayers will have to submit new and different information if they wish to claim a refund under Section 41. To help clients, prospects, and others, Wilson Lewis has provided a summary of the key details below.
Eligible research activities must pass a four-part test to qualify for the tax credit, also known as the Research & Experimentation (R&E) tax credit. The activity must be technological in nature, have a specific purpose or goal, seek to eliminate, or reduce uncertainty, and be conducted in a process of experimentation. The activity need not succeed; if the four-part test is satisfied, the activity and its related expenses fall under the tax credit.
The credit can be carried forward up to 20 years and lookback studies are permitted to claim the credit retroactively up to three years.
There are two calculation methods: traditional and alternative. Generally, established companies with prior research activities use the traditional method while start-ups and companies without prior research activities use the alternative method.
The traditional calculation method yields a 20 percent credit taken against current year research expenses, over a base amount. To qualify, the company must have had annual R&D expenses over the last four years. The alternative calculation method yields a 14 percent credit taken against current year research expenses if those expenses are more than 50 percent of the prior three years’ average. If there aren’t three years of average research expenses to pull from, the alternative method will produce a six percent credit.
In either case, companies will need documentation to support the credit, which includes but is not limited to:
Smaller companies can also claim the credit against payroll taxes or the alternative minimum tax (AMT). To qualify, they must have annual gross receipts of $5 million or less in the current year (payroll tax credit) or average gross receipts of $50 million or less in the three previous years (AMT credit).
After January 22, 2022, the IRS will require certain documentation and information with an application for a refund under Section 41 – the R&E (or R&D) tax credit. Providing this information upfront will help the IRS more quickly evaluate refund claims and decide which returns will need to be reviewed.
Required information will include:
Submit all the above information along with the annual tax return. The signature on either Form 1040 or 1120 will serve as the official declaration that all information is correct and accurate. Taxpayers may also submit a credit study justifying their refund claim; however, they must indicate specifically which pages contain the relevant information or it will not be accepted.
If the IRS deems the information complete, it will issue a refund immediately. Otherwise, refund claims will be subject to further review.
Further guidance is needed to clarify the business component requirement. It could mean different sectors or departments within the company itself. Or it could mean something as extensive as segmenting out research expenses by product, process, software, technique, formula, or invention used in the trade or business – which could total thousands of pages in some cases. Either way, the documentation requirement for R&D credit refunds is about to get much more intensive.
The good news is Atlanta companies have until January 22nd to submit refund claims as normal but are encouraged to begin applying the new requirements. It is expected the IRS will issue guidance in the coming weeks to provide additional information. If you have questions about the information outlined above or need assistance with an R&D tax credit, Wilson Lewis can help. For additional information call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.