Section 41 of Tax Cuts and Jobs Act of 2017 (TCJA) Section 174 provides a tax credit to incentive taxpayers to invest in research and development. But, since the beginning of 2022, Section 280(c), which has the purpose of avoiding bigger modifications on federal taxes and houses the provisions related to research and development (R&D), indicates that a taxpayer must reduce the amount chargeable of to a capital account only if the gross R&D amount exceeds the amount of the allowable research deduction for the year.
Across the software development field, companies are experiencing an existential problem by an income tax season that came with shocking tax bills resulting from this change in R&D costs. The problem was the misinformation about the tax provision that allows R&D amortization, which had taken a lot of small businesses by surprise with the massive tax bills this spring. From small software developers to large technological businesses, the pain is being felt everywhere with tax bills coming up to an almost drained cash flow, difficult financial decisions, bringing the need to take loans or extend lines of credit, ask VCs for more money, freeze hiring and contemplate layoffs – all of this at a time of tighter bank leading, higher rates and in the worst fundraising environment in over a decade.
Taking that into account, many software firms say that they can make it through this year but without the R&D full expense treatment back, survival can become an issue soon. The software development field is the clearest example of the fallout from the R&D tax change, since its biggest expense is software development talent and, until tax year 2022, the companies could fully expense the costs with developers as R&D rather than having to amortize them over the years. Still, industry success relies on the contribution of software talent, but when that cost overwhelms cash flow and profile, it potentially makes the business model untenable.
What is the 280C(c) election?
280(c) is an election made on a currently filed tax that reduces the amount of research and development tax credit by the corporate tax rate. That way, the taxpayer is not required to add back the amount of the R&D tax credit to income.
The regular method for calculating the research and development tax credit is done by multiplying the qualified research expenses by 20%, with the amount of the credit being added back to taxable income (increasing income tax). Then, the R&D credit is applied, reducing tax by the amount of the credit. The actual benefit under this method is the amount of R&D credit less the tax applied to the credit add-back. Thereby, the higher the tax rate to the taxpayer, the higher the additional tax and lower the general benefit. By electing the reduced credit election under IRC Section 280(c), there is no add-back, and the R&D tax credit is calculated using 15.8% rather than 20%.
While all of this happens, there has not been any substantive guidance on either Section 174 amortization or the related Section 280(c) language, and the current federal Form 6765 instructions for tax year 2022 still contain the previous concerning 280C, indicating the deductions reduction by the amount of gross credit if not electing the 280C. This could mean the IRS maintains that taxpayers must still reduce their deductions, or the instructions still need to be revised once further Section 174 guidance is issued, which creates one more reason for the taxpayers to extend their returns to wait and see if the Section 174 amortization requirement is repealed and full deductibility is restored.
How FI Group can help your company
FI Group is a worldwide lead consulting firm, whose target is the Management of Public Tax Credits for Research, Development & Innovation (RD&I). If you want to know what can be done to help your investments and your company’s growth, contact us to learn more about our services and how we can help you. Through global support, FI Group can give you all the answers and opportunities for claiming R&D.
