As a CPA led business and tax advisory firm, we are experts in tax reduction strategies and navigating complex tax laws in order to unlock savings for business owners like you. We do this by getting to know you, your goals and your business. One of our specialties is the Research & Development (R&D) Tax Credit under IRS Section 41 which is connected to Research & Experimentation (R&E) expenses under IRS Section 174.
Navigating Changes to IRS Section 174: Research and Experimentation Expenses
Before the changes of the Tax Cuts and Jobs Act (TCJA) in 2017, IRS Section 174 allowed businesses to immediately deduct R&E expenses incurred in the course of their business operations. However, starting with tax year 2022 onwards, this is unfortunately no longer the case!
Under the new rules, businesses are required to capitalize and amortize certain R&E expenses over a five-year period (or 15 years if the research is conducted outside the United States). This change can lead to an increase in your taxable income and an increase to your tax liability, as you can no longer deduct the full amount of these expenses in the year they are incurred.
This is a huge change in the law from when it was first implemented in the 1950’s which was designed to be very taxpayer friendly and allow immediate expensing of research costs.
Industries Affected by Tax Law Changes: Amortization of Research Expenses
The changes introduced by the TCJA to IRS Section 174 Research Expenses impact a wide range of industries. Businesses that engage in any form of research and development activities are likely to be affected by the new amortization requirements. These industries often include, but are not limited to:
- Technology & Software: Companies that develop new software, applications, or technological solutions. These businesses often have significant R&E expenses related to product development and improvement.
- Pharmaceuticals & Healthcare: Businesses involved in the development of new drugs, medical equipment, or healthcare solutions. Research costs in these industries can be substantial.
- Manufacturing: Firms focused on improving or developing new manufacturing processes, techniques, or equipment.
Industries That Can Benefit from Research Tax Credits
While the changes to Section 174 may increase taxable income for some businesses, the R&D Tax Credits under IRS Section 41 can help you reduce your tax liabilities. For example:
- Technology & Software: Costs related to software development, beta testing, and improving existing software can qualify for R&D tax credits.
- Pharmaceuticals & Healthcare: Expenses involved in clinical trials, process improvement, and the development of new drugs or medical equipment can be eligible for these credits.
- Manufacturing: If you’re improving manufacturing processes, developing new materials, or creating new, more efficient machinery, these activities may qualify for the R&D tax credit.
- Food & Beverage: Companies that experiment with new recipes, brewing processes, or preservation techniques may also be eligible for R&D tax credits.
Many other industries can also benefit from these tax credits as well.
Identifying Qualifying Expenses
These expenses typically include wages, supplies, contract research expenses, and certain indirect costs associated with your R&D activities. However, as there is currently not a lot of guidance from the IRS, many more expenses may fall under this category.
Harnessing the Savings under IRS Section 41: Research & Development Tax Credits
While changes to Section 174 might increase your taxable income, R&D Tax Credits under IRS Section 41 offer an opportunity to offset this increase. This allows businesses to claim credits for increasing research activities, creating a dollar-for-dollar reduction in your tax liability. This makes it even more important to obtain and maximize these tax credits.
How R&D Tax Credits Are Calculated
The calculation of R&D Tax Credits involves a multi-step process that includes identifying qualified research expenses (QREs), determining a base amount, and then calculating the credit. It can be a complex process, but we understand these calculations and can ensure you’re getting the maximum benefits.
How Can This Benefit Your Business?
By strategically leveraging both IRS Section 174 and Section 41, you can potentially counterbalance the increased taxable income from the TCJA changes to R&E expense deductions. The R&E expenses can still be expensed over time, while the R&D Tax Credit can directly reduce your tax liability, potentially offsetting any increases in taxable income.
We’re Here to Help You Save on Taxes
We’re here to help you understand and apply this and many other often overlooked tax reduction strategies to save you money on taxes. Don’t get caught by surprise or face an IRS audit because you didn’t correctly categorize your research expenses due to changes enacted under the TCJA.
Want to know more about how research tax credits can benefit you? Don’t leave money on the table. On average we help our clients save over $54,238 in taxes per year!