Since its inception in 1981, the Federal Research and Development (R&D) tax credits have been a path for the government to incentivize businesses to pursue innovation, research and generally find ways to improve the country. However, with the end of 2021 right around the corner, we are poised to see two significant changes to the way that businesses engage with the R&D tax credit. The first of these is a change to the filing requirements for tax amendments to be eligible for R&D tax credits, and the second and far more significant one is a change to the way the companies treat their R&D expenditures for tax refund purposes.
The federal incentive has seen many extensions and revisions over the years, but few have been as polemic and potentially disruptive as the latter of these changes.
If your company makes use of R&D tax credits significantly as a way to deduct the expenses incurred during the year through research and development, or you normally file your R&D credit as a tax amendment, then you need to be aware of the changes that are coming to the government incentive in 2022.
New Tax Amendment Requirements in 2022
Currently, if you want to amend your tax return to claim a refund through R&D tax credits you only need to file form 6765 with your amended return. However, back on October 15, 2021, a memorandum was released by the Chief Counsel’s office of the IRS that stated there would be a new process starting on January 10, 2022. Memorandum number 20214101F states that for the R&D tax credit to be valid, the taxpayer has to identify all the business components for which the claim applies in the given year.
On top of identifying each business component related to the R&D credit claim, you must also identify for each of them all the research activities performed, the individuals involved in these activities, and the information each individual was aiming to discover through said activities.
On top of that, you must also provide the total qualified employee wage, supply, and contract research expenses for the claim year (this can be done using form 6765).
New Specificity Requirement
The memorandum also refers to a new specificity requirement that needs to be met in order for claims to be approved. This requirement states that the taxpayer must provide a written statement for the refund claim that verifies all the previous requirements. This statement must state that the tax declaration is made under the penalty of perjury, with the taxpayer’s signature attesting to the veracity of the claim and its attached proof. To quote the memorandum, “a purported claim is deficient if the taxpayer fails to provide sufficient facts in the manner required by the specificity requirement, and it may be rejected by the Service as such”. Basically, if sufficient proof is not provided, your tax amendment claim will be rejected.
While initially, it seemed like this change in the filling procedure would apply to all R&D tax credit refund claims, it was later clarified that this new filing requirement only applied to amended tax returns. While that remains the case, for now, nothing says that the IRS won’t make this a general requirement down the road.
The R&D Amortization Provision of the 2017 TCJA
The changes to the tax amendment filing process are relatively minor when compared to the second change coming in 2022. Starting with the tax year that begins on January 1, 2022, businesses will be required to capitalize and amortize all their R&D expenses over five years. For companies operating outside of the United States, the amortization period will be 15 years instead.
Right now, businesses have two options when it comes to how they treat their R&D expenditures. They can deduct the R&D expenses in the same year in which they were incurred or defer and amortize them over a minimum of 60 months (five years). But now, only the five years’ option will be available to businesses through capitalization and amortization of their R&D expenses.
However, we have known for a while now that this change was coming. The new way to handle R&D expenditures is actually part of an amortization provision included in the 2017 Tax Cuts and Jobs Act (TCJA). Many industry experts have decried the provision, saying it would hurt the United States’ ability to be competitive in the R&D field. As such, there has been a lot of effort to repeal it, with two bills brought forward that among other things aimed to repeal this change, the American Innovation and R&D Competitiveness Act of 2021 and the American Innovation and Jobs Act. Unfortunately, so far, neither of these has passed.
The Build Back Better Act also includes a provision that would delay the implementation of this amortization change to 2026, but experts feel that simply pushing back the measure would be insufficient and that it needs to be repealed for the USA to remain competitive.
Since the Build Back Better Act has yet to pass and by the government’s own admission most likely won’t go through this year, it’s all but certain that the new amortization changes will go into effect for 2022.
How to Prepare for the Changes
Preparing for the new filing requirements isn’t necessarily a big issue. You just need to ensure that you provide the extra documentation and file form 6765 when turning in your tax amendment if you are seeking an R&D refund.
Unfortunately, this simplicity doesn’t apply to the amortization change. You will need to consider several factors, and they affect your tax strategy.
Your cash flow planning, accounting methods, technical accounting, and the FASB ASC Topic 740 might need to be looked at in order to be better prepared for what’s coming. For cash flow planning, looking into federal and state loss carryforwards that are available to you would be a great place to start. You should also look into accounting changes that could provide favorable results for tax purposes, such as deferring revenue or accelerating deductions.
Contacting your tax advisor to overview these upcoming changes to the R&D tax credit and what needs to be done on your end to adapt to them is an absolute must.
What The Future Holds
For companies working with R&D or those that take advantage of these tax credits, 2022 will be a complex year. The changes to the tax amendment process for R&D tax credits are not earth-shattering, but it could be a look into the future of R&D claims for the IRS. Still, the amortization changes are clearly the most significant of the two, and whether they will stick around or be pushed back by the Build Back Better Act or another bill remains to be seen.
The only certainty right now is that next year you’ll have to provide proof if you seek to file for R&D tax credits as part of a tax amendment and that you won’t be able to deduct R&D expenses in the same year they were incurred, but rather over 5 years instead. So, make sure to take this into consideration when you are planning your 2022 tax strategy.
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