For tax return filings with respect to the 2022 tax year (typically filed in 2023 for the 2022 tax year), a company cannot fully expense their research expenditures under IRC § 174 for the year, instead they must amortize such expenditures over five years. The new rules require companies to capitalize and amortize all IRC § 174 domestic qualified research expenses, including software development expenditures, over five years, using the halfyear depreciation convention.
This change to the rules impacts the research credit because prior to 2022, an expense that was not categorized under IRC § 174 could still be used for the IRC § 41 credit if the expense could have been claimed under § 174. However, in 2022, in addition to the capitalization/ amortization requirement, in order to claim the costs as a qualified research expense under IRC § 41, the costs must be treated as an IRC § 174 expense and capitalized over five years. This means all expenses claimed in the research credit computation under IRC § 41 must be captured as IRC § 174 costs and amortized over five years.
As an example, in 2022, an employee is paid $120,000 and performs qualified research activities. In order for a company to claim the employee’s $120,000 of wages as a qualified research expense under IRC § 41, the company must claim the $120,000 as an IRC § 174 cost, subject to amortization over five years rather than be able to fully expense the cost.
The second big change to the research tax credit took effect on January 10, 2022 where the IRS requires all research tax credit refund claims to include the following documentation in an attached statement with the tax return:
The IRS indicates that the information required in the first two bullets above should be written out in a statement rather than simply providing documents. If a company provides a Technical Report, the IRS states that the company must cite the exact pages that support the specific items mentioned above in an attached statement, merely providing the documents such as a Technical Report will be considered insufficient and invalid.
Although the information was routinely requested during IRS audits, these items are now mandated when submitting a research credit claim for refund in order for the IRS to process a refund request.
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