R&D Tax Credit News

Despite recent guidance from the IRS regarding Section 174 amortization, businesses remain unsure about the impact of Section 174 and for good reason. Many are wondering whether they should accept government contracts or not for fear that it will be subject to Section 174. Businesses that were expecting to have a loss are now, in some cases, projected to be in a positive tax position due to Section 174. To help paint a clearer picture of the impact of Section 174 and who it impacts, we have outlined an example below to illustrate the result.

Example:

A business has $1,000,000 in direct expenses that it can use to generate a R&D Credit. Rather than traditionally being able to deduct 100% of those expenses, that business now can deduct only 10% of those expenses in Year One and amortize the remaining 90% of those expenses over the next five years. As a result, in Year One, $900,000 of the $1,000,000 in direct expenses would not be able to be deducted and would end up back in net income.

Who Would be Affected?

In this case, any business that was projected to be profitable would have to pay tax on an additional $900,000 in income. Also, businesses that were expecting a loss of up to $900,000 would now be profitable and expected to pay some income tax.

Who Would not be Affected?

In this scenario, any business projecting a loss of more than $900,000 would still operate at a loss despite Section 174.

Best-case scenario for both R&D Credit and Section 174

Using these numbers in the example, businesses that were within their first five years of receiving their first revenue and projected more than a $900,000 loss would still operate at a loss while having usability of the R&D Credit to use against payroll tax. $1,000,000 in direct expenses would translate to approximately $60,000 in Federal R&D Credits (you are not able to use State R&D Credits for payroll offset), and to reduce your payroll tax due by $60,000, the credits must be included on a timely-filed return.