The R&D tax credit is a tax incentive that encourages companies to invest in research and development activities in the United States. The credit is available to businesses that engage in qualifying R&D activities, such as developing new or improving existing products, processes or software.
For technology companies in the United States, there have been several recent changes to the R&D tax credit:
- Permanent extension of the credit: The R&D tax credit has been permanently extended, which provides technology companies with greater certainty and stability when planning their R&D activities.
- Expanded eligibility for small businesses: The Protecting Americans from Tax Hikes (PATH) Act of 2015 expanded the R&D tax credit to include certain small businesses that previously could not claim the credit due to their size or structure. This change benefits many small and medium-sized technology companies.
- Alternative simplified credit (ASC): The ASC is a simplified method for calculating the R&D tax credit. The ASC allows businesses to claim a credit of up to 14% of their qualified research expenses.
- Payroll tax offset: Beginning in 2016, qualified small businesses (defined as those with less than $5 million in gross receipts and those in their first 5 years of existence) can elect to use the R&D tax credit to offset their quarterly payroll taxes, which can provide a significant cash flow benefit. For tax year 2023 and beyond, the maximum election amount has increased from $250,000 to $500,000, where up to $500,000 in credits per quarter are applied against employer-paid FICA and Medicare taxes. This is a significant change, as businesses no longer need to incur federal income tax liability to monetize the R&D tax credit.
- Elimination of the AMT limitation: The Alternative Minimum Tax (AMT) is a parallel tax system that applies to certain high-income taxpayers. Prior to the Tax Cuts and Jobs Act of 2017, the R&D tax credit was limited for AMT purposes, which reduced its value for some businesses. The Tax Cuts and Jobs Act eliminated this limitation, which increases the value of the credit for affected businesses.
- R&E capitalization requirement: Starting with the 2022 taxable year, the Section 174 R&E capitalization requirement may drive a technology company’s desire to reexamine potentially qualified research expenditures to increase their research credit and lower their overall income tax liability.
Many of the activities performed by technology companies, while seemingly routine, can qualify for the R&D tax credit program. See below for a non-exhaustive list:
- Experimenting with new features or functionality for existing software.
- Designing new cybersecurity and data encryption techniques to prevent breaches.
- Conducting unit, end-to-end, and performance testing.
- Architecting blockchain technology to securely track assets and transactions.
- Creating backend and frontend architecture for a new software product.
- Improving performance of system software, such as operating systems and compilers.
- Developing AI algorithms and machine learning models.
- Engineering software that interacts directly with a hardware product to function as a unit.
Takeaways
These are some key changes to the R&D tax credit that technology companies in the US should be cognizant of. It’s worth noting that the specific rules and regulations around the credit can be complex, so it’s crucial for businesses to consult with R&D tax credit specialists to ensure they are properly claiming the credit.
Authors: Austin Jensen, MBA | [email protected] and Tyler Collins, CPA, Principal | [email protected]
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For more information on this topic, please contact a member of Withum’s R&D Tax Credit Services Team.
