“Pivot” may have been one of the most used terms in 2020 as organizations quickly adjusted to the disruption of the COVID-19 pandemic. Impact on supply chains and physical work environments brought changes to the way of doing things for organizations across the board. To the extent your organization undertook activities that were new or different from what you had done before, you may find you are eligible for an often-generous federal tax credit program for research and experimentation.
R&D Tax Credit Mechanics
The federal tax credit for research and experimentation, sometimes referred to as the R&E or R&D tax credit, provides an incentive to offset the costs of developing new processes or products or modifying manufacturing processes or techniques. It can be worth up to 10% of the costs spent on R&D activities, which potentially reduces current year tax liabilities dollar-for-dollar. It also can be claimed retroactively – and this element is key for your current year planning. Your organization not too late to claim the credit for the 2020 tax year, and R&D tax credits can also result in cash refunds from amending previously filed returns. This could be a huge benefit as organizations consider strategies to recover from disruption and align strategies for what comes next.
Although traditionally the R&D tax credit was available for organizations that produced taxable income, changes made in the 2015 law commonly known as the Protecting Americans from Tax Hikes (PATH) Act broadened the program to include smaller businesses. Organizations that have $5 million or less in gross receipts in the claim year and had no gross receipts prior to 2016 can claim an R&D credit of up to $250,000 against their payroll tax liability.
Defining What Activities Qualify for R&D
Certain industries may have a clearer idea of which activities potentially qualify for the credit. Software companies are frequent beneficiaries, as are companies in the medical device and pharmaceutical sectors. During COVID-19, however, everyone had to pivot in some shape or fashion to continue operations, which opens the door for companies large and small that may not have considered the R&D tax credit program in the past.
For example, local distilleries started producing hand sanitizer. Manufacturers that could, began production of personal protective equipment (PPE) and others entered into the market for ventilator production. Others may have helped make disinfectant products and precious household paper goods that were in short supply.
Many new technologies developed to facilitate remote service offerings needed additional investments to ensure information security, both of which potentially become eligible R&D activities. On the retail front, many smaller organizations rapidly expanded ecommerce options to allow for order placements and deliveries when in-store shopping was limited. Health clinics and providers may have added additional investment into virtual tools to permit telehealth visits.
The need for medication and treatment options for the virus itself may have enticed more start-ups into the field. Because of the amount of R&D that goes into the process, pharmaceutical and life science activities tend to draw significant benefits from R&D tax credits.
Defining Eligible Costs for R&D
The challenging component of claiming the R&D tax credit lies in determining which expenses related to the technological development, novel process, or significant reworking of an existing system are qualifying research expenses (QRE) to be covered by the credits. Working with a provider who understands the intricacies of the application is crucial because often QREs are buried in general ledger accounts. In the past, whether an expense is eligible for the R&D tax credit has been brought to tax court. A R&D tax credit consultant can help you get the most benefit from the credit, including planning which tax year to take the credits as well as ensuring you have a defensible, well-documented position for your QREs.
If you have taken the credit in the past, note that staffing changes may affect your total QRE amount. Furloughs, for example, will affect your overall wages that can be used, as well as the total hours worked. Organizations that downsized should pay close attention to their calculations for 2020 to ensure these adjustments have been adequately captured. The wage expenses covered by any forgiven Paycheck Protection Program (PPP) loans will also take additional consideration.
Potential for More R&D Tax Credit Changes
Much of the federal relief effort for 2020 focused on tax offerings, and it may be that R&D incentives comes up in future legislation. One that might be on the short list given its effective date is a change made as part of the tax reform law known as the Tax Cuts and Jobs Act (TCJA). The TCJA created a requirement to capitalize R&D costs starting in 2022 and amortize those costs over a five-year period. In 2021, companies would immediately expense R&D tax credits, which makes it more appealing for companies to make R&D investments in 2021. It may be that Congress also moves to take action against the requirement to capitalize R&D tax credits; indicators suggest a repeal of the TCJA provision has bilateral support.
Another item to watch for would be whether the R&D tax credit becomes part of an incentive to keep more businesses – manufacturers in particular – operating domestically. President Biden’s presidential campaign tax proposal laid out plans for an incentive for manufacturers to stay in the U.S. and it could be that part of this initiative’s aims to increase benefits for new product development done in the U.S.
For More Information
We will continue to monitor for tax developments as they become available. For more information about the R&D tax credit, please contact a member of our team.
Published on March 22, 2021
© Copyright CBIZ, Inc. and MHM. All rights reserved. Use of the material contained herein without the express written consent of the firms is prohibited by law. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.
CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ). MHM (Mayer Hoffman McCann P.C.) is an independent CPA firm that provides audit, review and attest services, and works closely with CBIZ, a business consulting, tax and financial services provider. CBIZ and MHM are members of Kreston International Limited, a global network of independent accounting firms. This publication is protected by U.S. and international copyright laws and treaties. Material contained in this publication is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their organization.