Research and Development Credit Changes

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To get businesses to expand their research and development costs domestically, Congress passed a law to allow them to take a tax credit on their return for the amount of research and development expenses that are paid during the year in the United States.

Starting in tax year 2022, though, the Research and Development Credit (Credit) changed dramatically due to the Tax Cuts and Jobs Act by making businesses amortize the credit over a 5-year period. Because of this, it will be important to understand the calculation as well as the after-tax effects of taking the Credit before deciding to take it.

First, it is important to note which expenses qualify for the Credit. To qualify, the expense must be undertaken to discover technological information, intended to develop new or improve a current business component or experimentation costs. It is also important to note that foreign expenses in the form of research in social sciences, arts or humanities and a grant or contract to a foreign business or individual are not considered research expenses eligible for the R&D Credit.

Once the amount of expenses for the credit is determined, it is important to decide which approach to take. The simplified approach (which most businesses choose to use) of the Credit is calculated by taking 14% of the research and development expenses in excess of 50% of the average research and development expenses over the past 3 years. This amount is then added back to taxable income (increasing taxable income) and then 20% of this amount is taken as a Credit over the next 5 years, starting with the year of the expense.

Because the credit is not taken in its entirety in the year of the expense, the business may owe taxes in the initial year of the Credit. The Credit over the following years greatly outweighs the tax deduction in the first year. Please consult one of DSWD’s tax advisors for a complete analysis.