Over the past few weeks, TCG President Michael Krajcer and I have had the pleasure of speaking on the recent changes to the R&D tax credit at several of the OSCPAs 2016 spring accounting shows.
We owe a great big thank you to all of the Ohio CPAs out there who took the time to attend our sessions and kept things lively and interactive. In fact, we got so many great questions on the R&D credit we decided to share 14 of our favorites—along with our answers of course!
- How do you calculate the credit if you’re a startup? Similar to any taxpayer, the first thing you need to do is undergo an analysis to determine that your work meets the qualifications for the R&D tax credit. Once you know that you qualify, there are specific startup rules and formulas that must be followed in order to calculate the credit. Specifically, the base amount calculation will be measured by the first year that the startup has QREs, as opposed to the general 1984 through 1988 time period analysis.
- Is there a way to preserve the credit for startup companies, since most will not be able to utilize it? Yes. In general, there is a 20 years carry forward provision with the R&D tax credit. Any taxpayer, (including startups) unable to utilize the benefit will have up to 20 years to carry it forward.
- There used to be a restriction that prevented startups from including vendor costs in their credit calculation. Has that changed at all under the PATH Act? No. Unfortunately, the new regulations have not addressed that limitation. As of today, startup companies not yet “carrying on a trade or business” that wish to claim this credit, can only include wage or supply costs as qualifying expenses. Any contract research expense or cost being paid to third party vendors cannot be included in the credit calculation.
- In regard to the new payroll tax offset provision included in the PATH Act, will employees end up paying less in payroll taxes? No. In the case of the new payroll tax offset provision; the credit benefits the employer, not the employee. The credit itself goes toward the 6.2% employer share of the FICA tax. There will be no impact to the employee’s FICA tax contribution.
- What form do you use to report the payroll offset? Form 8794. To date, this form has not yet been released so it’s still unclear how the reporting process will work. Likely, in addition to this new Form, there will be updates to Form 6765 to allow for credit tracking.
- Since there is talk about raising the Alternative Simplified Credit (ASC) rate from 14% to 18%, has there been any talk about raising the 6% credit rate for startup companies? At this point in time, we are not aware of any talk or any bills that are working to increase the credit rate for startup companies.
- How does an S-Corp utilize the R&D tax credit? The research credit is calculated at the S-Corporation entity level, and allocated to the shareholders pursuant to the provisions of the articles of incorporation. The credit allocation is included in the K-1 received by the shareholder, and then utilized (subject to limitations) in the shareholders tax return to offset tax liability related to the entity generating the credit.
- If you are deducting packaged software, can it be included as a qualifying research expense (QRE) under “supplies?” Packaged software that is purchased for use in your trade or business would typically not qualify as an allowable expense, since it is not a “tangible” asset and therefore specifically excluded.
- 401k contributions are excluded from the credit but what about company match and profit sharing contributions? For in-house research expenses or the wages paid to a qualifying employee, costs that are subject to withholding can typically be included in the research credit. For credit calculation purposes, that means you would use the individual’s Box 1 wages from their W-2 form. If company 401K matching and profit sharing contributions are not treated as taxable income (and thus included in the Box 1 amount) they cannot be included in the credit as QREs.
- Can the design and construction of real estate qualify for the R&D credit? Yes, to the extent that the activity can meet the 4-Part Test of the credit, design and build in the real estate construction industry is not subject to any specific exclusion.
- Could the development of marketing/advertising campaigns qualify for the credit? Typically not. Though developing a concept for a marketing and advertising campaign would certainly fall under market research, this type of research is specifically excluded from the R&D credit. This exclusion covers any research related to style, taste, or cosmetic/seasonal design factors.
- Isn’t there some type of rule, where if an individual spends a certain percentage of time on R&D efforts, that you can claim all their wages? Yes. This is the “Substantially All” rule, or what is often referred to as the “80% rule.” Under this rule, if an individual is spending 80% or more of his or her time on qualifying research activities, 100% of the individual’s wages can be includible within the credit calculation.
- Is there any type of De Minimis exclusion preventing individuals with low qualifying percentages of R&D time to be includible within the credit calculation? No. If any individual is spending any percentage of his or her time working on qualifying R&D activity, (whether it’s 2% or 98%) the comparable salary percentage of the individual can be included in the credit calculation.
- How do you amend an Ohio Return for an R&D Tax Credit Claim? What is the process actually like, and how does it work? Ohio provides for a four year statute of limitations, meaning that there is generally an opportunity to claim credits from the prior four years. Beyond that, the process to amend an Ohio return for an R&D tax credit claim can be a bit confusing. First, the credit must be calculated after the tax year has ended, and all actual activity/expense is known (i.e. cannot use estimates). Then, only the 4th quarter of the related year can be amended and a refund claimed. Any excess credit can be carried over for a period of seven years, but a separate Form CAT-CS must be prepared for each of the quarterly CAT returns being amended and a claim for refund must also be filed for each amended quarter, via Form CAT-REF.
So, there you have it—14 excellent questions taken directly from our audience of Ohio CPA’s.