Research and Development (R&D) expenses underwent a radical change at the beginning of 2022. The Tax Cuts and Jobs Act of 2017 mandated that these expenses could no longer be expensed inside a given tax year.
Now they must be amortized over 60 months or five years. This change is causing significant problems for many small businesses.
Let’s say that your small business did $1M in sales last year and had exactly that same amount in expenses. Normally, you would be at a break even point having no income tax liability.
But let’s say that half of your expenses were for R&D. With the tax law change now in effect, you can only deduct 10% of those expenses or a total of $50K for R&D Expenses in 2022.
This would leave you being forced to pay tax on $450K. In certain situations, if you have a lousy accountant, this could shut you down.
Congress included this change back in 2017 to help pay for the corporate tax rate reduction and the Qualified Business Income Deduction of the Tax Cuts and Jobs Act. Most of us expected it to be repealed prior to going into effect at the beginning of last year.
Both sides of the aisle have said that it should be repealed, but the warring factions have differing ideas on how to do it. Democrats want to tie the repeal to an expanded Child Tax Credit. Republicans say that expanding the Child Tax Credit further would provide even more of a disincentive for people to go to work in the first place.
President Biden’s budget proposal is mute on the subject entirely. We can only hope that Congress will get its act together and do something to fix the problem sometime this century.
Let me leave you with this.
Changes in the deductibility of R&D Expenses have in no way altered the existing R&D Credit. You can still do both.
There are two basic R&D Credits. One is for small business start-ups to cover the employer side of payroll taxes. This credit limits out at $500K annually and can be taken for up to 5 years.
The other more common credit is a dollar for dollar credit that reduces income tax. It is taken on qualified R&D Expenses which are normally anywhere from 6% to 8% of a company’s gross expenses.
There is no upper limit on this credit. Both can be carried forward up to 20 years to cover income tax liabilities. If you could have taken the credit in the past three years, an amendment can be completed to claim it.
The qualifications for the credit are as follows…
1 – The activity must be related to improving the functionality, quality, or reliability of a business component.
2 – The process must be technological in nature being based on a hard science such as engineering, physics, and chemistry or the life, biological, and computer sciences.
3 – At the beginning of the process, there must have been an uncertainty as to its success in creation or implementation.
4 – There must have been a process of experimentation with multiple design alternatives or a trial and error approach.
Successfully completing these credits is no small feat. This isn’t as simple as filling out one of the usual IRS Forms. It takes time, documentation, education, and talent.
If you would like to see if your firm potentially qualifies for the credit, please contact us today.
Accounting Solutions Ltd. stands ready to complete our mission and purpose of protecting you, your family, and your business. Whether you need Employee Retention Credits, M&A Due Diligence, Payroll Services, or Accounting and Tax Work, you have but to ask. I’m here and I remain,
Sincerely yours,
Chris Amundson
President
Accounting Solutions Ltd.
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