As Election Day grows closer, tax professionals are keeping a close eye on the two major parties’ policies and how each may potentially impact their R&D tax planning strategies over the next four years.
Currently, the U.S. government is underinvesting in overall R&D relative to historical norms. On a per capita basis, the U.S. now only ranks 24th out of 34 when it comes to R&D tax incentives.
Additionally, as noted in a recent report released by the Information Technology and Innovation Foundation, due to a provision of the Tax Cuts and Jobs Act (TCJA), starting in 2022, companies will no longer be able to expense their R&D costs in the first year. Instead, they will have a five-year amortization period, causing the U.S. ranking to drop to 32nd out of 34.
In 2017 when the current administration enacted the TCJA, R&D tax credits saw an indirect impact when the corporate tax rate was simplified by eliminating the tiered tax rate structure. This change increased the value of the R&D tax credit that corporate taxpayers were able to claim.
However, as noted above, unless legislation is passed to extend existing provisions, changes to the timing of R&D deductions will negatively impact those R&D tax incentives.
Conversely, the opposing party proposition is to repeal certain parts of the TCJA and changing some of the current tax structure in order to increase federal funding.
So where does each party stand on R&D and what does it mean for corporate taxpayers?
The current administration is focused on investing in several key technologies, such as artificial intelligence (AI), quantum information science (QIS) and 5G communications.
As a result, the administration has supported sizable increases in R&D budgets for these technologies, with a focus on R&D efficiency and increasing returns from federally funded R&D. In 2019, the National Institute of Standards and Technology (NIST) released its report “Return on Investment Initiative for Unleashing American Innovation,” which was designed to inform future policy decisions.
When considering the opposing party’s position on R&D, they have proposed investments of approximately $300 billion over four years, with a specific focus on breakthrough technologies, many of which overlap with the incumbent party’s key industries. This investment would be a significant step in boosting the competitiveness of U.S. R&D compared to other nations.
In addition, the opposing party would look to amend existing small business support initiatives to enhance R&D benefits for minority and women-owned businesses. This includes supporting regional innovation initiatives by creating a national network of free incubators and innovation hubs co-located with Small Business Development Centers (SBDCs), libraries, HBCUs, community colleges, MSIs, etc.
Historically, there has been broad bipartisan support for the R&D credit and its expansion. Therefore, regardless of the election outcome, investment in R&D will likely continue to be at the forefront of each candidates’ policies.
R&D Tax Credits: How do They Work?
The R&D tax credit is one of the largest annual tax credits available to U.S. companies, yet many don’t apply out of fear they won’t qualify. Well, that thinking is so yesterday. Over the last four decades, lawmakers and regulators have taken steps to remove qualification barriers, enabling more companies and more industries to benefit from the credit. How does a company qualify? And what goes into claiming the credit? We’ve got it all covered right here.
R&D Tax Credit Criteria: A Four-Part Test
For companies that qualify, the R&D credit is practically a reward for doing business as usual. Qualifying activities can include the development or design of new products, patents, intellectual property or software, with qualifying expenses covering things like employee salaries, supplies, and even contract research.
To be considered for the credit, there are four criteria that your activity must meet:
1- Your activity must attempt to develop a new or improved product, process, software, technique, invention, or formula that increases performance, function, reliability, or quality in some way. The best part? Your company doesn’t actually need to achieve improvement or innovation—it just needs to attempt it.
2- It must rely on a hard science. This means the research or development process must be technological in nature or based in engineering, physics, chemistry, biology, or computer science.
4- There must be an attempt to eliminate uncertainty. Not sure whether that new machinery will actually speed up your production process? Test it during this stage to find out. Of course, the attempted innovation must go beyond aesthetic improvements and pertain to the development of methodology, design, techniques, formulas, or inventions. And remember, the rule is “attempt” to eliminate uncertainty. You don’t have to know whether you can achieve this goal, but you do need to show you at least tried to find out.
The activity requires experimentation to eliminate or resolve technical uncertainty. This means you must demonstrate that you tried alternative solutions–modeling, simulation, systematic trial and error, or other methods—to create or develop your product or process.
Claiming Your Credit: Documentation is Key
According to the most recent IRS data, in 2014, more than 17,824 companies claimed $12 billion in federal R&D tax credits. But for many companies, the challenge to claiming R&D tax credits isn’t actually qualifying, it’s documenting that they qualify. So, if you’re eligible to claim an R&D tax credit, it’s important to keep track of the details from the get-go.
Try setting up documentation-retention policies and engaging your tax employees. R&D tax credit reports will ask for a project analysis and quantitative information like expenses, gross receipts, and revenue information.
You might also need supporting information such as project notes, lists, specifications, requirements—or even prototype drawings. Having these materials on hand when it comes time to submit your claim will help the process run more smoothly.
R&D regulations are changing all the time, especially in a new administration or presidential term. Curious to see what the next four years might mean for the R&D tax credit?
“For many companies, the challenge of claiming R&D tax credits isn’t qualifying—it’s documenting that they qualify.”