Changes to the R&D Tax Credit

Since its enactment in 1981, the research and development (R&D) tax credit has provided significant monetary benefits to eligible companies. While the research credit is now permanent, there have been several developments in the law related to the credit and the associated expense treatment of research and experimental (R&E) costs under IRC Sec. 174 in the past few years.  

Payroll Credit Limitation Changes 

Prior to 2015, the R&D tax credit could only be utilized against income taxes. In 2015, the Protecting Americans from Tax Hikes (PATH) Act altered the law to allow qualified small businesses to use R&D credits of up to $250,000 against their payroll tax liability. This was considered a huge win for small businesses engaging in R&D activities and, thus, encouraged innovation even if the businesses were not yet profitable.  

In August of 2022, President Biden signed into law the Inflation Reduction Act (IRA), which increased the benefit limit to $500,000 to aid qualified small businesses and encourage them to continue innovating.  

Eligibility 

The eligibility for the R&D Payroll Credit remains the same. A qualified small business is a corporation, partnership or S corporation that has: 

• Less than $5 million in gross receipts in the current tax filing; and/or 

• No gross receipts prior to a five-tax year window that includes the tax filing year. 

Section 174 Capitalization Requirements 

The Tax Cuts and Jobs Act (“TCJA”) of 2017 changed how companies must treat IRC Sec. 174 expenses. For tax years beginning on or after January 1, 2022, taxpayers can no longer deduct R&E expenditures under IRC Sec. 174. Companies must now capitalize costs identified as R&E expenditures, and such costs must be amortized ratably over a five-year period for domestic research or over a 15-year period for foreign research. 

The TCJA also expanded the definition of an R&E expense. Under IRC Sec. 174, an R&E expense is specified as: “research or experimental expenditures that are paid or incurred by the taxpayer during such taxable year in connection with the taxpayer’s trade or business.” In addition to the original definition, the following has been added: “Any amount paid or incurred in connection with the development of any software shall be treated as a research or experimental expenditure.” 

These changes will affect all taxpayers currently claiming or planning to claim the R&D tax credit going forward, especially taxpayers who are not currently assigning R&E expenditures to a capital account. This change requires an additional step in tax preparation each year to calculate IRC Sec. 174 R&E expenditures each year. 

Overall, it is good news to see a payroll offset limitation increase. The main concern is the changes regarding IRC Sec.174. While some guidance has been released by the IRS, there are still outstanding questions for taxpayers. Over the past year, legislation has been introduced to eliminate this requirement going forward. Despite these attempts, the capitalization and amortization changes remain in effect as of this writing. 

An EisnerAmper Webinar titled: “The New R&D Tax Credit Rules” covered the specific changes that have been implemented for 2023 regarding the payroll credit offset limitations and the treatment of R&E expenses under IRC Sec. 174. 

Webinar panelists included: 

• Tim Rankins, Tax Director, EisnerAmper 

The EisnerAmper Corporate Tax team has decades of experience assisting clients with questions about research and development expenses and credits. Contact one of our professionals if you have questions about how these changes may impact your organization.  

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