Section 174 R&D Expenditures
For tax years commencing after January 1, 2022, taxpayers will be required to capitalize and amortize research and development (R&D) expenses that were previously eligible for immediate expensing.
Defined under Code Section 174, expenses incurred domestically (i.e., within the U.S.) will be amortized over a five-year period and expenses incurred abroad (i.e., outside the U.S.) will be amortized over a 15-year period. In the first year, all expenses are assumed to be incurred mid-year (i.e., July 1, 2022), so tax deduction for U.S.-based expenditures would only be 10% in the first year. Any sold or abandoned costs associated with the new section 174 capitalization requirements cannot recover the tax basis remaining when sold and or abandoned.
Under the Code, the expenses that are required to be capitalized not only include the qualified expenses that go into calculating the R&D tax credit under Section 41, but also include indirect costs that can be attributed to R&D activities. These indirect costs include typical overhead costs such as rent expense on facilities, utilities, and more. Additionally, costs incurred in connection with the development of software is required to be capitalized. It is important to note that the required capitalization of Section 174 costs does not have an impact on the R&D tax credit.
Employee Retention Credit is Winding Down
In late October 2022 the IRS published IR-2022-183, which warns employers to be wary of third-parties who are advising them to claim the Employee Retention Tax Credit (ERC) when they may not qualify. These third-parties are taking improper positions related to taxpayer eligibility. For concerned CPAs and taxpayers, the IRS indicated form 3949-A can be used for whistleblowers to report tax-related illegal activities related to ERC claims. Employers have until April 15, 2024, to file amended returns for Q1-Q4 of 2020 and until April 2025 to file amended returns for Q1-Q3 of 2021.
The ERC is a payroll tax credit that is available for Q1-Q4 of 2020 and Q1-Q3 of 2021 (recovery startup businesses can claim the credit for Q3 and Q4 of 2021). There are two ways to qualify for the ERC (not including the specific rules for recovery startup businesses). The first way to qualify is if the employer had a significant decline in gross receipts compared on a quarter-by-quarter basis. The second way to qualify is if the employer has been impacted by a full or partial shutdown due to a government order. It is important to note the following for partial shutdown rules:
- Many inconveniences related to COVID (e.g., additional costs, difficulty hiring, difficulty procuring products, etc.) do not rise to the level of qualification.
- Shutdown orders from government authorities are key for qualification under the Government Shutdown Test. Be wary of documentation without references to specific orders.
- Supply chain shutdowns require shutdown orders from a key supplier. The qualification criteria are not satisfied by general worldwide delays in supply chains.
Upcoming Change in Bonus Depreciation Beginning January 1, 2023
The Tax Cuts and Jobs Act (TCJA) passed in 2017 has expanded the bonus depreciation deduction rules under section 168(k) to allow for an immediate 100% deduction on qualifying property. The amount is set to drop by 20% each year beginning with property placed in service starting January 1, 2023. The bonus deduction allowed in 2023 is 80%, 60% in 2024, 40% in 2025, 20% in 2026, and 0% in 2027.
Qualifying property consists of property that has a useful tax life of 20 years or fewer. This includes, but is not limited to, computer systems, software, qualified improvement property, certain vehicles, machinery, equipment, and office furniture. Bonus depreciation is automatically applied by the IRS unless a taxpayer opts out, which can be done by attaching a statement to the tax return when filing. It is important to note that these changes will not impact Section 179 expensing and that several states have their own specific tax conformity rules regarding bonus depreciation.
Both new and used property can qualify for bonus depreciation. Generally, used property will qualify if it was not:
- Acquired as part of a tax-free transaction.
- Acquired from a related party.
- Used by the taxpayer or a predecessor before acquiring it.
Reminder on the Net Operating Loss Changes for Corporations
The passing of the TCJA in 2017 eliminated the carryback of net operating losses (NOLs) and permitted them to be carried forward indefinitely. When the corporation becomes taxable, the generated NOLs can then be used to reduce up to 80% of taxable income.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act enacted March 17, 2020, amended the NOL rules under Sec. 172 that were previously enacted by the TCJA to allow a taxpayer to carryback losses beginning after December 31, 2017, and before January 1, 2021, for up to five years. Starting January 1st, 2021, the NOL rules revert to the old rules created with the passing of the TCJA.
Inflation Reduction Act
The Inflation Reduction Act (IRA) signed into law on August 16, 2022, has provided several amendments to the tax code. Although not all-encompassing, below are some important changes:
- An amendment to the R&D tax credit rules for qualified small businesses (QSBs) doubles the amount of R&D credit that can be used to offset the employer-paid portion of a company’s payroll taxes for QSBs.
- Numerous energy incentives came about with the passing of the IRA including, but not limited to:
- Increasing the investment tax credit to 30% and extending the credit until 2032 (applies to solar panels, EV charging stations, etc.).
- Increased Section 179D incentives such as the Energy-Efficient Commercial Building Deduction. Eligible taxpayers will be able to claim a deduction of up to five dollars per square foot for eligible properties placed in service after 2022.
- For tax years beginning on or after January 1, 2023, the Act Imposes a nondeductible 1% excise tax on the fair market value of stock repurchased by publicly traded corporations.
State Incentives & Other Tax Planning Considerations.
There are several credits and incentives to be aware of from a federal and state level. Below is a non-exhaustive list of some of the more common income tax credits we have seen, including:
- Angel Investor Tax Credit
- Fixed Capital Investment Tax Credit
- Human Capital Investment Tax Credit
- Low Income Housing Credit
- Research and Development (R&D) Tax Credit
- Solar / Energy Tax Credits
- Work Opportunity Tax Credit
In addition to the above income tax credits, New Jersey has an expanded NOL Program that enables tech and life science companies to sell their New Jersey net operating losses and/or R&D tax credits for cash. Buyers can purchase tax credits at a discount and apply them to reduce taxable income.
In Conclusion
While the above items are a high-level summary, it is important to contact your tax advisor regarding the impact of these tax law changes on your filings. Wolf’s Tax team can help you determine whether you need to implement potential tax planning for the upcoming tax year.
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