In this insightful webinar, Jim Foster, J.D., Vice President of Tax at VerifyToday, provides expert guidance on navigating the complexities of the R&D credit and Section 174. With over 18 years of experience as a tax attorney, Jim has worked extensively with large corporations and small businesses alike, and is seasoned in production, audits, and the Internal Revenue Service (IRS).
Jim breaks down the fundamentals of the R&D credit, offers clarity on the intricacies of Section 174 amortization, and provides valuable insights into ongoing legislative updates. Here’s a breakdown of insights to ensure compliance and maximizing tax savings.
Key Takeaways
The Four-Part Test for R&D Credit Qualification
The R&D credit applies to research activities aimed at developing or improving business components for permitted purposes, such as functionality, performance, quality, or reliability.
The four essential criteria are:
- Business Component: Includes products, processes, software, or techniques.
- Permitted Purpose: Focuses on improving functionality, performance, quality, or reliability—not aesthetics.
- Process of Experimentation: Requires substantial testing and refinement to eliminate uncertainties.
- Technological Nature: Must be based on hard sciences like engineering, chemistry, or software development, excluding soft sciences like marketing or psychology.
Qualified Research Expenses (QREs)
- QREs fall into four categories: Wages, Contractors, Supplies, and Computer Costs.
- Expenses include direct researchers, direct support staff, and supervisors of research activities.
- Contractors are eligible but only at 65% of their cost due to statutory reductions.
Calculating the R&D Credit
Two methods for calculating credits are available:
- Regular Credit: Provides higher potential benefits but requires extensive historical data. Maximum benefit is 10 cents on the dollar.
- Alternative Simplified Credit (ASC): Easier to calculate using the prior three years of QREs, usually yielding 7–8.5 cents per dollar of QREs.
| Calculation 1 | Calculation 2 |
|---|---|
| (Historical QREs ÷ Historical Gross Receipts) × Avg. Annual Gross Receipts | 50% × Current Year QREs |
| Final Base Amount = The Larger of the Two Values | |
Tip: Evaluate both methods to determine the most beneficial approach
Section 174 Changes (Since 2022)
- Section 174 now requires amortization of research expenses over five years (domestic) or fifteen years (foreign)—eliminating immediate expensing.
- This change is mandatory and applies to both direct and indirect research costs.
- Non-compliance can result in significant penalties during IRS audits.
Legislative Outlook and Optimization
- Bipartisan interest exists in reverting Section 174 to immediate expensing, but proposed legislation continues to face hurdles.
- The American Innovation and R&D Competitiveness Act of 2025, introduced on March 10th, proposed eliminating Section 174 amortization from 2022 forward. However, high costs make retroactive relief unlikely to pass.
- Optimizing Section 174 expenses in conjunction with R&D credits is critical to minimize tax liabilities and maximize benefits.
Audit Considerations
- Failing to comply with Section 174 or improperly documenting R&D credits can trigger audits and hefty penalties.
- IRS requirements include detailed documentation and accurate reporting of qualified research activities.
- VerifyToday offers specialized guidance to help ensure compliance and minimize audit risks.
Notable Insights
- Compliance with Section 174 is mandatory; accurate categorization and reporting are essential.
- Balancing R&D credits against Section 174 is key to minimizing tax liabilities.
- Upcoming IRS changes for the 2024 tax year will require more detailed reporting of business components.
Actionable Takeaways
- Evaluate both Regular Credit and ASC methods to ensure maximum tax savings.
- Prioritize accurate documentation of research activities, especially for high-value projects.
- Stay informed about legislative changes and adjust compliance strategies accordingly.
Don’t Leave Money on the Table—Partner with VerifyToday!
Navigating the complexities of the R&D credit and Section 174 can be daunting. Ensure your business is fully compliant while maximizing your tax savings by partnering with Jim Foster and the VerifyToday team. With over 18 years of tax expertise and proven experience working with the IRS, Jim provides the guidance you need to confidently claim your credits and reduce your tax burden.
Reach out to VerifyToday to schedule a consultation!
