LIFO Accounting

Some WOTC Statistics

A survey conducted by Binder Dijker Otte (BDO), an international network of public accounting, tax, consulting and business advisory firms, in 2017 found that about 50% of surveyed firms who did not claim the R&D credit failed to do so because their company was not specifically focused on research and development . It is important to note that a business’s research does not have to be big or successful in order to qualify for the credit. 

$10 billion in tax savings is achieved annually by U.S. businesses claiming the credit, data from the National Science Foundation indicate that another $4 billion unclaimed R&D tax credits are untapped.

The federal Research & Development (R&D) tax credit is one of the most advantageous but underutilized incentives available to small and mid-sized businesses.

Originally introduced as a temporary measure in the Economic Recovery Tax Act of 1981 (ERTA), it has remained part of the tax code ever since benefiting thousands of companies in diverse industries. Yet, many more do not take advantage of the credit’s potentially significant benefits.

How does the R&D tax credit work?

Typically, 6% to 8% of a company’s annual qualifying R&D expenses can be applied, dollar for dollar, against its federal income tax liability.

What qualifies as Research and Development?

Activities that generally qualify for the R&D credit have to meet the IRS’s four-part test:

1. Permitted purpose

The activity must be related to developing or improving the functionality, quality, reliability or performance of a business component (i.e. product, process, software, technique, formula or invention).

2. Technological in nature

The business component’s development must be based on a hard science, such as engineering, physics and chemistry, or the life, biological or computer sciences.

3. Elimination of uncertainty

From the outset, the organization must have faced technological uncertainty when designing or developing the business component.

4. Process of experimentation

The company must have evaluated multiple design alternatives or employed a systematic trial and error approach to overcome the technological uncertainties.

Which Companies Qualify?

Companies of any size that perform qualified activities are eligible for R&D tax credits

Which Activities Qualify?

The following sample activities qualify for the R&D tax credits:

• Creating improved products, processes, formulas, software, and techniques
• Automating or improving internal manufacturing processes
• Designing tools, jigs, fixtures, and molds
• Integrating new equipment
• Development of software and firmware
• Mobile application development
• Internet of Things (IoT) development
• Development of data center, big data, and data mining tools
• Integration of APIs and other technologies
• Manufacturing new or improved products
• Developing prototypes, first articles, models
• Evaluation of alternative materials
• Development of firmware
• Network hardware and software development and optimization
• Developing simulators

Which Industries Typically Qualify?

• Aerospace
• Tool & Die
• Metal Fabrication
• Plastics/Injection Molding
• Consumer Products
• Manufacturing
• Architecture & Engineering
• Food & Beverage
• Financial Services
• Mortgage & Banking
• Construction/MEP
• Software Development
• Chemical
• Contract Manufacturing
• Pharma
• Oil and Gas
• Blockchain Development
• Game Development
• Any industry that develops or improves processes or products

How far back can you claim R&D tax credits?

Businesses can claim the R&D credit retroactively by filing amended returns for any open tax years, which in most cases, is three years. The time frame may be longer, however, if the organization endured losses during that period.

Is R&D tax credit taxable income?

The R&D credit reduces federal taxable income, meaning that businesses receive a dollar-for-dollar tax credit and still get to deduct expenses related to research and development.

Do R&D tax credits expire?

The Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently extended the R&D credits available under Section 41 of the Internal Revenue Code. If there is a lack of tax liability, business may carry unused credits forward for up to 20 years.

Note: The Refund statute is three years, meaning a company typically has three years (four for may state refunds) before the statute on the refund expires.  After that, that’s it– You walked away from the refund forever!

The R&D Credit is not currently available in the following states:

• Alabama
• Alaska
• Kentucky
• Mississippi
• Missouri
• Montana
• Nevada
• New York
• North Carolina
• Oklahoma
• Oregon
• South Dakota
• Tennessee
• Washington
• Wyoming

All other states have some form of Research and Development Tax Credit/Benefit Program in addition to the federal program.

Note:  This does not mean it is not available on the federal return!

Research & Development Tax Credit for Startups

The Protecting Americans from Tax Hikes (PATH) Act of 2015 introduced new, game-changing legislation for eligible small businesses, expanding the potential R&D benefit to businesses in start-up mode that are not paying income taxes yet.  Historically, businesses could only use R&D tax credits to offset income taxes, which generally excluded pre-revenue startups. With this new provision, these pre-revenue startups now qualify. Too few payroll startups are taking advantage of these significant benefits becuase they do not believe that they qualify.

Startups often miss out on R&D tax credits due to the assumption they haven’t grown or grossed enough to qualify. Effective January 2016, qualified small startup businesses can use the Research and Development Tax Credits to offset the FICA employer portion of the startup payroll taxes, annually, up to $500,000. This new component of the federal research and development tax credit was enacted to directly support startups that are not paying income taxes yet. 

Research & Development Tax Credit for Established Businesses

In the United States, the R&D tax credit serves as an incentive for businesses to engage in innovation and technological advancements. There are both federal and state R&D credits. There are different components of the federal R&D credit, each with its own rules and benefits. Here’s an overview of the four main types: 

Regular/Standard R&D Credit Method: Also known as the Traditional Credit or the Internal Revenue Code (IRC) §41 Credit, this method calculates the credit based on a fixed base percentage. The percentage is determined by considering a company’s qualified research expenses (QREs) and gross receipts in previous years, typically between 1984 and 1988. The credit is generally equal to 20% of the excess of the current year’s QREs over a base amount, which is a product of the fixed base percentage and average annual gross receipts during the four preceding years.

Alternative Simplified Credit (ASC) Method: The ASC is designed to simplify the calculation process and make the R&D credit more accessible for businesses that do not have detailed records from the 1980s. The ASC calculates the credit based on the increase in R&D expenses over the average from the preceding three years. The credit is equal to 14% of the excess of the current year’s QREs over 50% of the average QREs for the three preceding tax years.

R&D Energy Credit: This component of the R&D credit is related to contributions or payments made to third-party organizations that conduct energy research. To qualify for the energy credit, businesses must adhere to stringent and specific rules and requirements regarding the organizations that can receive these contributions. The credit is generally equal to 20% of the qualified research payments made to energy research consortiums during the tax year.

Basic Research Credit: Available only for C corporations, the basic research credit is related to contributions or payments made to third-party organizations that conduct scientific research. Specific rules and requirements determine which organizations qualify to receive these contributions. The credit is generally equal to 20% of the excess of the qualified research payments made to universities and other qualified organizations during the tax year over a base amount.

What is research and development?

Research and development, also known as R&D, is the process by which a company works to generate new knowledge that it might use to create new technology, products, services, or systems that it will either use or sell.

Many people think of pharmaceutical and technology companies when they hear “R&D.” Still, other firms, including those producing consumer products, also invest time and resources into R&D.

Any business that create and sells a product or service, whether software or spark plugs, invests in some level of R&D.

Basic vs. Applied Research

Research and development comes in two main types: basic and applied.

Basic Research

Basic research (also known as fundamental research) focuses on improving our understanding of a particular problem or phenomenon by exploring big questions. Some examples of basic research questions are:

• Why do mice get caught in traps?
• Why are some people allergic to gluten?

While basic research can certainly help a company acquire new knowledge, its focus on research for its own sake means that the financial benefits are uncertain. Consequently, large corporations, universities, and government agencies primarily perform this type of research and development.

Applied Research

Applied research is also done to acquire knowledge. But unlike basic research, it’s done with a specific goal, use, or product in mind. Where basic research is theoretical, applied research is practical, focusing on finding workable solutions for current problems. Some examples of applied research questions include:

• How can we build a better mousetrap?
• What combination of flours will produce the best gluten-free pie crust?

R&D is typically done to effect different outcomes as follows:

New Product Research and Development

R&D and product development often go hand in hand. Rapid changes in consumer demands and emerging technologies mean there’s always a need to adapt. Before developing new products, you need a deep understanding of the market and the user needs. This lays the groundwork for the development of the new product.

Various concepts are generated and tested at the outset. These can then be prototyped for further research and testing.

Improving Existing Products and Processes

The continual evaluation of existing products, services, and processes is also a crucial part of R&D. If a product, service, or process is no longer profitable or adding value in a market, it risks stagnating.

It could also be that technology has been developed to facilitate improvements that may cut costs, make efficiency gains or improve safety. This can include improvements to the manufacturing and production processes of the product.

Legislative changes or shifts in user wants can also mean a product or process must change or evolve to remain viable.

What sectors does R&D occur in the most?

Research and development occurs across various sectors and industries and in companies of all sizes. These range from intensive R&D industries that rely heavily on R&D projects like pharmaceuticals, life sciences, automotive, software, and technology to areas like food and drink. R&D also plays a significant role in the construction industry, particularly manufacturing and engineering.

Businesses may have two option when it comes to calculating the federal research and development (R&D) tax credit. Depending on the circumstances, they may be able to use either the Regular Research Credit (RRC) Method or the alternative simplified credit (ASC) method.

What is the regular research credit calculation (RRC) method for the R&D tax credit?

The RRC method allows for a credit of 20% of a company’s current year Qualified Research Expenses (QREs) over a base amount. This approach can be complicated because to calculate the credit, businesses need the average, annual gross R&D receipts over the prior four tax years and if they began operations in the 1980s or prior, they must gather data from some of those years.

What is the alternative simplified credit (ASC) method?

Unlike the RRC method, the ASC method doesn’t require gross receipts as a component of the R&D tax credit calculation. Instead, it looks at QREs over the previous three-year period. This allows companies that lack the historical records necessary to document their base amount to determine their eligibility and file for the R&D tax credit. Under certain scenarios, the ASC may even allow businesses that are ineligible under the regular credit method to qualify for the R&D tax credit.

How do you calculate the R&D tax credit using the alternative simplified credit method?

As of 2009, the ASC is defined as 14% of QREs incurred in the current tax year, above 50% of the average QREs in the previous three years. If the taxpayer had no QREs during any of those three prior years, the credit is calculated as 6% of the QREs in the current tax year.

Using these guidelines, the four-step simplified calculation process is as follows:

1. Identify and calculate the average QREs for the prior three years
2. Multiply average QREs for that three year period by 50%
3. Subtract half of the three-year average (Step 2) from current year QREs
4. Multiply the result of Step 3 by 14%

For example, in Step One, a company has identified the following qualified historical research expenses:

2019 $50,000

2020 $110,000

2021 $120,000

2022 $130,000

2023 (Current Year) $140,000

The average QRE for the prior three-year period (2020- 2022) would be $360,000/3=$120,000.

In Step Two, the company determines half of this amount or $60,000.

In Step Three, the company takes its current year QRE amount of $140,000 and subtracts the $60,000 three-year average for a total of $80,000.

In Step Four, the company calculates its ASC by multiplying $80,000 by 14%, for a credit of $11,200.

ASC Method Summary

Three-year average QREs (2020-22) $120,000

Half of the three-year average $60,000

Current QRE-three-year average $80,000

Credit: $80,000 x 14% $11,200

When should a company choose the ASC vs. the RRC R&D calculation method?

In certain circumstances, such as a decline in R&D spending, companies may no longer qualify for the R&D tax credit using the RRC method. This doesn’t mean, however, that they are entirely excluded because the ASC may still be an option.

For example, if a company’s R&D efforts become more efficient and, therefore, less costly, it can negatively impact the ratio of its R&D spending relative to its gross receipts. The business may then fail to meet the requirements set in the “base period” under the terms of the law and be ineligible for the credit under the regular method.

Generally, a business should consider both the RRC and ASC options and when either potentially applies, calculate the credit using each methodology to determine which is most beneficial.

How do the RRC and ASC R&D tax credit calculation methods compare?

Compared to the ASC, the RRC R&D tax credit calculation may result in a larger credit under some scenarios, particularly those where the base amount is low. Other optimal circumstances for using this method occur when the business is a startup or its R&D expenditures are relatively recent. Note, however, that the RRC calculation is more complex than the ASC and often requires a great deal of effort to gather the requisite data – a task that some businesses are unable to do.

Now, let’s compare our sample ASC calculation from earlier with the RRC method calculation using the additional details below:

Current Year QREs $140,000

Fixed base percentage 3%

Average annual QRE gross receipts over four years $250,000

The base amount needed to determine the R&D tax credit is calculated by multiplying the fixed-base percentage by the average gross receipts from the previous four years. This result, in this case, is $7,500.

Base amount $7,500

Greater of base amount or 50% current QREs $70,000

Excess of current QREs over minimum base amount $70,000

X 20% regular credit Calculation Rate $14,000

Based on these figures, the RRC method vs. the ASC qualified tax credit amount would be as follows:

RRC R&D Tax Credit Calculation ASC R&D Tax Credit Calculation

$14,000 vs. $11,200

The above example highly oversimplifies the calculation and the process of claiming the credit. 

How can Legacy Tax & Resolution Service (LTRS) help determine R&D tax credit eligibility and filing?

With an unmatched combination of tax credit experience, technology and resources, LTRS makes claiming R&D tax credits as simple, streamlined and predictable as possible. We assist CPAs and their clients with financial inquiries and help them strategize the most effective ways to utilize tax credits. In addition, LTRS continuously monitors for changes in legislation and compliance requirements at the federal, state and local levels that may affect tax credits.

Who We Help

Put the Section 41 Research & Development tax credit program to work for your business, your clients, or your customers.

R&D Tax Credit Services for CPA Firms & Tax Professionals

Include R&D tax credit services in your client offerings to minimize tax risk and increase profit margins

Protect Your Clients’ Bottom Line

Extend your service offerings beyond traditional CPA and tax firm capabilities to help your clients optimize return on investment

R&D Tax Credit Services for Financial Service Firms

Big picture tax and financial insight that maintains compliance and drives business value

Increase Working Capital

Leverage Legacy’s Consulting’s team of innovation tax professionals to develop customized solutions for clients that help them achieve their financial and professional goals. 

R&D Tax Credit Services for Business Owners

Protect your profits and drive cash flow to your bottom line

Maximize Business ROI

Tap into the dollar-for-dollar savings power offered by the research and development tax credit to optimize your return on overall investment

WHY LEGACY TAX & RESOLUTION SERVICES?

Dedicated To R&D

No need to be the guinea pig for your CPA or other tax professional.  We average 10-20% more funding than a CPA or other tax professional, not familiar with the nuances of the R&D program.

R&D Program Specialists

Our team R&D Department strictly focuses on R&D, allowing us to be the experts and resulting in more funding for your business.  This includes the supporting calculations and documentation required to be submitted with each application to the IRS.  See below what makes our application package different.

Audit Protection Included

If you get audited, we will supply all criteria and assist in responding to the IRS.

Lightning Fast Results

Our proprietary process allows for faster results, which means faster funding.  We have perfected the communication process with our stakeholders to work a case from initial submission through application submission with the IRS. 

Maximum Funding

We evaluate your claim in every way possible to ensure we maximize your credit.

Professional Support

Although our process is quick and painless, we have answers with a dedicated team of ERC support specialists when you have questions.

What Your Business Can Expect, Using Our Services to Process Your R&D Application

Because of the aggressive and inaccurate claims made by “R&D Mills,” the IRS has issued several warnings about ensuring that your R&D credits can be verified. The IRS demands detailed documentation and proof of compliance, including tax aggregation and attribution rules. Businesses and organizations must know the issues and take the necessary precautions to ensure their R&D claims are valid.

With so much on the line, attempting to complete a fully supported application on your own can be overwhelming. That’s where Legacy Tax & Resolution Services comes in. Our experts help you navigate the complex world of Research and Development Tax Credits and deliver audit-ready reports that will give you confidence in your R&D Credit Application. Regarding the R&D Application Package submitted to the IRS, we believe in providing a package that will make the job of reviewing your case and reaching an approval decision by the IRS Agent fast and efficient. By providing an audit-ready R&D application, we accomplish three objects, 1) Because your application has been pre-audited, the application is ready for a quicker approval by the IRS reviewer 2) Your chances of being selected for a post-approval audit is considerably reduced because of our pre-audit process, 3)  While no company can completely prevent a random audit, should you be selected, you know that your company is ready.

Below is what we provide

• Audit Ready Report with Submission – Our Research Team builds a solid qualification case for every client. They create timelines and arguments to prove your qualifications for the R&D. Our audit-ready reports include all of the memos, write-ups, qualification summaries, and employee support necessary to assist the IRS agent in verifying your R &D claim and sustaining your claim in the event of an audit.
• Qualification Criteria – Exactly how the business qualifies (ASC or RRC) is laid out in considerable detail as if we were preparing for an audit.
• How Statutory Requirements Were Addressed – Taking into consideration Tax Aggregation and Attribution rules
• Qualified Wage Details – Break down payroll information by employee per quarter, including eliminating any majority owners and those related to the majority owner by Attribution Rules. Take into consideration the employer size test and the allowable qualifying wages.
• 4 Part Qualification Test– We spend an extensive amount of time gathering information from the client to provide a pre-audit application package for submission to the IRS.

Preparation of Forms

The R&D tax claim needs to be submitted along with your annual entity or personal tax filing. Here is what you need to file:

• Form 6765, Credit for Increasing Research Activities.
• Form 3800, General Business Credit. This form has a line that asks for the amount of Credit for Increasing Research Activities.
• Each state will have its own form if it offers a state R&D tax credit program. If you qualify for the payroll tax offset, you will need to make sure you account for it on Form 941, Employer’s Quarterly Federal Tax Return. You will also need to fill out and attach Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities.
• Documentation requirements as stated in I.R.C. § 41
• Accurate and supportable numbers allow you to claim the tax credits you are eligible for confidently.

How complicated is the R&D?

Enacted in December 2017, the Tax Cuts and Jobs Act of 2017 (TCJA) amended Section 174 to require capitalization of all research and experimental (R&E) costs incurred in tax years beginning after Dec. 31, 2021. This rule was a major change in tax policy. Since 1954, taxpayers had been able to elect to deduct R&E costs as incurred. The rule also was a departure from U.S. GAAP, which normally allows immediate expensing of research and development (R&D) expenditures under Accounting Standards Codification 730, “Research and Development.” 

Taxpayers were hoping that the provision would be repealed or delayed prior to the due date for filing 2022 tax returns. However, as of the date of publication of this article, the fate of relief remains uncertain. In addition, there are numerous technical and procedural questions about Section 174 amortization that remain unanswered. The IRS has said that it is working on guidance, but nothing has been released yet. Given this background, taxpayers should consider what steps they should take now to manage this uncertainty. 

Wow this is way to complicated for me to try on my own

Continued IRS Changes to the Research and Development Credit Program

Section 174 amortization 

For tax years beginning on or after Jan. 1, 2022, R&E costs must be amortized over five years if the R&E activities are performed in the U.S., or over 15 years if the activities are performed outside of the U.S., beginning with the midpoint of the tax year in which the costs were paid or incurred. Furthermore, taxpayers may not immediately deduct the unamortized basis attributable to R&E costs for any property disposed of, retired, or abandoned during the amortization period (in other words, the amortization continues for its remaining life). 

Because immediate expensing of R&E costs has been permissible for nearly 70 years, it was not necessary to distinguish R&E costs from other immediately deductible expenses. Therefore, for many taxpayers, additional effort will be necessary to comply with Section 174 if it doesn’t get repealed or delayed before their tax returns are due. The extent of that effort will depend on the size of the taxpayer’s business, the industry, the taxpayer’s global footprint, and the taxpayer’s current methods for characterizing these expenses. 

In addition, taxpayers will have to consider how capitalizing R&E costs would affect the following: 

• Cash flow impact. Taxpayers should plan for the impact on the increase in estimated tax payments needed to cover additional federal and state tax liabilities due to the deferral of R&E deductions. 
• Tax provision impact. The TCJA provision creates a disparity between the timing of deductions for R&E costs for GAAP and the timing of deductions for income tax accounting purposes. Therefore, taxpayers should determine how they will account for deferred tax assets attributable to capitalized R&E costs. 
• Foreign tax issues/Section 199A deduction. The allocation of R&E costs under Treasury Regulation Section 1.861-17 affects foreign tax credit usage, the foreign-derived intangible income (FDII) deduction, global intangible low-taxed income (GILTI), the base erosion and anti-abuse tax (BEAT), the determination of effectively connected income, and the Section 199A qualified business income deduction. Taxpayers should consider the impact that the deferral of deductions for R&E costs will have on these items. 
• Tax accounting method changes. Taxpayers historically have been required to file an automatic accounting method change to change from expensing to capitalizing R&E costs. This method change had been on a cutoff basis without requiring an IRC Section 481(a) adjustment, meaning changes were applied on a prospective basis. Currently, the procedures for implementing the TCJA change to IRC Section 174 have not been published. While the IRS could require a method change similar to the current automatic change, this is not the only way that the law could be implemented.  
• Loss on abandoned projects. Historically, taxpayers choosing to capitalize R&E expenditures for specific projects were permitted to write off the remaining basis if the project was disposed of or abandoned. Under TCJA, taxpayers are required to continue to amortize R&D expenditures over their remaining useful life. This rule seems contrary to other provisions in the IRC relating to abandonment costs, such as IRC Section 165.  
• R&D credits. Federal and state R&D credits are available to taxpayers that meet the qualification criteria outlined in IRC Section 41. The credit qualification criteria specify that qualified research expenses must meet the definition of R&E expenditures under IRC Section 174. Consequently, taxpayers should consider how capitalizing qualified research expenses will affect the R&D credit. On the bright side, a more thorough analysis of R&E costs might result in opportunities for additional R&D credit benefits. Of note, even if a taxpayer is not claiming an R&D credit, the requirement to capitalize and amortize R&E costs still is applicable. 
• State and local tax. For states that use federal taxable income, the requirement to capitalize and amortize R&E costs could increase the tax liability at the state and local level. 

Research and Development Tax Credit (R&D) Rules and Regulations = 3,922 Pages to Navigate

In 2022, the significant changes to Section 174 went into effect. Enacted in 1954 as part of the Internal Revenue Code (IRC), Section 174 was created to eliminate uncertainty in tax accounting treatment of research and experimental development (R&E, or more popularly, R&D) expenditures and to simply encourage research and developmental experimentation as to way to grow innovation.

Section 174 allows businesses to either deduct or amortize certain R&D costs. Deductions can be made in the year in which they are paid or incurred, or they can be amortized over a period of not less than 60 months, beginning with the month in which the taxpayer first realizes benefits from the expenditures. Below are five things to know now about the updates to Section 174.

1. Which entities are subjected to Section 174 capitalization?

In short, Section 174 applies to any taxpaying entity that incurs qualifying R&D costs independent of specific industry or business size. Specifically, there are several types of businesses that are impacted, including:

• Corporations — Regardless of size, once corporations have incurred qualifying research and development costs;
• Small businesses including startups — Regardless of current profitability status, small businesses and startups that are heavily invested in R&D may capitalize or amortize their research expenses;
• Sole proprietorships, partnerships, and LLCs — Also, these entities can take advantage of Section 174 if they have qualifying R&D expenses; and
• Past-through entities including S-corporations — These too can utilize Section 174 for eligible cost associated with R&D, and the R&D credits can be passed through partners, individual shareholders, or members.

2. What qualifies? What are the kinds of costs subject to Section 174 capitalization?

There are several categories of expenses that can be subject to Section 174 capitalization, including:

• Salaries and wages — The salaries and wages of employees who conducting or directly supervising or supporting research activities can be capitalized;
• Supplies and materials — The cost associated with supplies used in the research process can be capitalized, including anything from lab equipment to the software required for the research;
• Patent costs — The cost associated with obtaining patents for a product or process developed through research activities can be capitalized;
• Overhead expenses — There are certain indirect expenses that can be allocated to research activities, including utilities for a research lab or depreciation on research equipment; and
• Contract research expenses — If a third party is used to conduct the research on a company’s behalf, the cost can be capitalized.

3. What kinds of items are excluded from Section 174 deductions?

Not all R&D expenses can be deducted under Section 174. For example, costs for land or depreciable properties are not deductible. Additionally, costs associated with research conducted after the beginning of commercial production, marketing research, quality control, and funded research (such as research funded by any grant, contract, or otherwise by another person or governmental entity) are generally excluded.

4. What is considered R&D as defined by Section 174?

For tax purposes, the following four-part test from the Internal Revenue Service must be met in order to qualify for R&D credit:

• Business purpose — The research must be intended to benefit a business component, which can be any product, process, computer software, technique, formula, or invention that is to be held for sale, lease, license, or use by the company in a trade or business of the company.
• Technological in nature — The business component’s development must be based on a hard science, such as engineering, physics, chemistry, the life or biological sciences, engineering, or computer sciences.
• Elimination of uncertainty — The activity must be intended to discover information that would eliminate uncertainty about the development or improve of a product or process.
• Process of experimentation — The business must evaluate multiple design alternatives or have employed a systematic trial-and-error approach to overcome the technological uncertainty.

5. Which states have conformity to Section 174?

Companies will have to check with the individual state in which they are filling in to determine if that particular state has conformed. States either conform to the IRC Section on a rolling basis or a static basic. A state that conforms on a rolling basis means it will automatically adopt any changes to the federal tax code as those changes occur. Some states that conform on a rolling basis include Illinois, New Jersey, New York, and Pennsylvania.

States that conform on a static basis adopt the federal tax code as of a specific date and do not automatically incorporate subsequent changes. Some static states include Florida, Georgia, Virginia, and North Carolina. There are some states that have selective conformity (this means they adopt selective portions of the IRC), including Arkansas, Colorado, and Oregon.

It is worthwhile to note that levels of conformity can vary by state and may be subject to specific adjustments, additions, or exceptions based on the individual state’s tax laws.

American Innovation and Jobs Act

On March 16, 2023, Sens. Maggie Hassan (NH), Todd Young (IN), and 10 others introduced Senate Bill 866, the “American Innovation and Jobs Act”. The proposal is designed to promote innovation and job growth in the United States by repealing changes to Section 174 capitalization and amortization provisions of the Tax Cuts and Jobs Act (TCJA, also known as the Trump Tax Cuts). The bill also expands the Section 41 Research & Development (R&D) tax credit for qualified small businesses in three ways.

The American Innovation and Jobs Act Explained

The American Innovation and Jobs Act addresses these concerns by repealing the TCJA changes to Section 174. By doing so, the bill will restore the option of immediate expensing of R&E expenditures and return businesses to a more favorable investing and tax environment for research and development.

This repeal is crucial for fostering innovation in the United States, as it reduces the financial burden on all businesses investing in R&D. By allowing companies to immediately expense their R&D costs and claim the deduction against current-year income, the American Innovation and Jobs Act reduces the tax burden of innovation.

Expanding Section 41 R&D Credit for Qualified Small Businesses

In addition to repealing the TCJA changes to Section 174, the American Innovation and Jobs Act also expands the Section 41 R&D credit for qualified small businesses (QSBs) in three key ways:

• Extending the duration of the payroll tax offset from five to eight years, providing a longer period of financial support to small businesses investing in R&D.
• Increasing the credit percentage for qualified research expenses from 14% to 20%, further incentivizing businesses to invest in R&D activities.
• Increasing the cap on the payroll tax offset over the next 10 years from $500,000 to $750,000.

The American Innovation and Jobs Act, through its repeal of the TCJA changes to Section 174 and expansion of the Section 41 R&D credit, recommits to a culture of fostering U.S. technology and growth. By removing unnecessary barriers to R&D investment and further extending financial incentives to small businesses, this legislation is poised to stimulate economic growth and help maintain the United States’ competitive edge in the global market.

We’re urging companies interested in the restoration of Section 174 R&D deduction choices to contact their federal legislators to express their support. For any questions regarding the repeal of Section 174 and expanding R&D Credits please don’t hesitate to contact us.

We’ve Cut Through the R&D Tax Credit Confusion for You

If you tried researching the Employee Retention Credit program, or even tried to do this yourself you are fully aware of the confusions and complexities. 

Much of the R & D information found on page 1 of Google may already be outdated by the time you read it.

Yeah, This is way too complicated to try on my own!

WOW! Still not convinced you should not try this on your own.  Well then, let’s try to get you prepared as MUCH AS POSSIBLE!

Quick R&D Checklist

• Did you document the decline in Gross Receipts/Revenue by quarter correctly? Ensure you’ve accounted for non-operating income and investment income. Determine first if aggregation is required, per a control group scenario. Remember not to include unrealized gains and losses or PPP loan proceeds. Last, be sure you can tie the ERC reported revenue back to financial statements and/or tax reporting documents.
• Did you take part in other federal grant programs (including PPP loans)? Wages and health care expenses may not be used for the ERC if they are used for PPP loan forgiveness, or other tax credits and grants. Complicated guidance has been issued (Notice 2021-20). Incorrectly submitting the PPP forgiveness application may lead to the inadvertent exclusion of ERC eligible wages.
• Did you take an advance ERC in Q4 of 2021? Employers who took an advance ERC before the program had been officially terminated will have to pay that money to the IRS by the end of Q4 2022 or face penalties and interest.
• Have you carefully documented local/state shutdown “orders”? These orders will be local and state orders, not federal “guidance,” nor will this apply to choices made by management to curtail operations in the interest of safety. Orders that disrupted businesses are those that made conducting business unlawful and impossible. A business that is “essential” will have more difficulty qualifying.
• Do you utilize a payroll company or payroll technology? While the ERC was originally intended to provide immediate cash relief, refunds are taking many months to reach taxpayers. Organizations using a PEO will likely find that their credits are further complicated by the reporting requirements for filers who operate under co-
• employment agreements.
• Additionally, payroll platforms may offer to process this credit, but their “opt in” programs have small print leaving the eligibility determination to the taxpayer and advising them to consult experts. Further, payroll processors do not have access to all the information required. Most importantly, the ERC documentation they often provide is inadequate, leaving the taxpayer vulnerable to an audit.
• Are you a part of a larger controlled group? Determining Control Group status is complicated and should be done first, by experts. If there are related entities, via common ownership or control, all the entities in that group must be assessed as one common employer; each entity does not qualify alone. This is different from the PPP qualification process.
• Did you correctly report ERC wages? ERC wages are not deductible for federal income tax purposes in the year of payment and should be recorded and reported in the quarter to which the credit applies. For cash basis taxpayers, this is an unwelcome surprise. Improper claims, or late reporting, could result in interest and penalties.  Also, many times, owner wages must be excluded from the calculations.
• Did you review and account for (or not) owner and owner’s family payroll? You may not be allowed to include owner wages, or employees who are related to the owner.
• Did you file the correct version of form 941X? Form 941X has been reissued multiple times. Taxpayers must use the correct version, or they’ll be rejected.
• Have you considered all reporting requirements, even before credits are received? Most of these credits are material and should be reported on tax returns and financial statements well before the credits have been received.

Pointers and Pitfalls

The following will help clarify or avoid pitfalls within the ERC regulations.

1. ERC legislation allows an employer to take an ERC on the healthcare costs for a furloughed employee, even if they are not collecting wages.
2. There is complexity in defining “partial” business, or commercial, interruption.
3. Be careful. There’s room for interpretive trouble when it comes to counting full-time workers. The legislation refers to full-time staff and points to prior language indicating that full-time employees are those who worked 30 hours a week or more on average in 2019.
4. Zooming or other telecommuting can rule out qualifying wages. If everyone goes home and promptly telecommutes, even if there’s a government stay-at-home order, the business has not been disrupted.
5. The CAA eliminated, at least for now, the requirement that eligible wages for an employee not be higher than they were in a prior quarter.
6. Owner wages, and any owner family wages, may have to be excluded in calculating eligible wages.
7. The ERC program was eliminated for the 4th quarter of 2021 to help fund infrastructure legislation.

DID COVID IMPACT YOUR BUSINESS AS A RESULT OF?

• Partial/Full Shutdowns
• Limitations of group meetings
• Supply chain interruptions
• Inability to find or retain employees
• Increase in cost of wages/goods
• Reduction in goods or services
• Interruption to operations
• Inability to travel or attend conventions
• Cut down in your hours of operations
• Started new business after February 15th, 2020

If you had any of these issue, you owe it to yourself and your business to find out if you qualify.

How You May be Eligible for the R & D credit even for back years!

No Significant Decline in Gross Receipts?

You can still qualify. The “full or partial suspension of operations” (or “FPSO”) test is not a financial statement test. Therefore,  a business is not required to have any decline in gross receipts to evidence the existence of a FPSO. Congress created this test recognizing that: (1) gross receipts do not always tell the full picture of a business’ COVID hardship; and (2) even profitable businesses may have had to make tough employee retention decisions due to COVID-19-related changes to their business. For example, a company may be successful in one line of business and not another, causing total revenue to increase while certain business lines suffer or diminish. The ERC was designed to encourage the retention of employees in both profitable and non-profitable businesses.

Deemed an Essential Business?

No problem. The Internal Revenue Service (“IRS”) explicitly states that an essential business may be eligible under the FPSO test. The FPSO test looks for a  full or partial  suspension of business operations. Hence, a full closure or shutdown is not required.

Not Materially Impacted by Government Orders?

That’s OK. The IRS carefully chose the words “more than nominal” to identify a situation where operational modifications and restrictions could result in a FPSO. The IRS did not use “substantial,” “material,” or other similar thresholds which may have suggested that a major impact be identified. Therefore, operational disruptions that are slightly more
than inconsequential may substantiate ERC eligibility.

Segmentation to Qualify!

To further complicate the matter, the IRS allows employers considering the ERC to first break their business into different “segments” (…think locations, divisions, services lines, business units, etc.) and then asks whether any segment of the business experienced a FPSO. If one of the company’s “segments” experienced a FPSO, a FPSO is deemed to have existed for the entire business, so long as such segment accounted for more than 10% of the revenue or service hours of the entire business in 2019.

One of the most important things to remember is that it is generally never just one operational modification or restriction that is used to support a FPSO; oftentimes, it’s the accumulation of several different operational restrictions or adjustments which, on their face, might seem inconsequential but in the aggregate constitute a FPSO.

Research & Development Credit (R & D) Spotlight:

1. Reduction In Revenue

The ERC allows qualified employers to recover wages and health plan expenses incurred during COVID-19.

• For 2020 periods, businesses can recover 50% of qualified costs, up to $5,000 per employee
• For 2021 periods, businesses can recover 70% of qualified costs, up to $7,000 per employee, per quarter for the first three quarters.

Employers are eligible to claim up to:

$26,000 per employee

Many taxpayers do not realize that Congress passed legislation at the end of 2020 allowing taxpayers to claim the ERC even if they took the PPP loan. This was not previously permitted.

With over 100 pages of ERC statute and regulation, and the credit now in its third iteration, the ERC can present challenges. Legacy Tax & Resolution Services will help you navigate this incentive for both future quarters and retroactively.

2. Impacted by Government Orders (include supplier chain disruptions)

If a governmental order had more than a nominal impact on your business operations, such as:

• Fully or partially suspension of operations tied to governmental orders
• Inability to obtain critical goods or materials from supplies because they were required to suspend operations due to governmental orders
• Limiting occupancy to provide for social distancing due to governmental orders
• Governmental orders to shelter in place preventing employees from going to work.

3. Recovery Startup Program

Companies founded after February 15th, 2020, are likely eligible for a special form of employee retention tax credits (ERC or ERTC’s). These businesses are called “Recovery Startup Businesses’’ in the context of employee retention tax credits.

Now that’s a mouthful, but it’s actually really important for your startup, especially if your company was incorporated or founded after February 15th, 2020. The American Rescue Plan Act of 2021, acknowledges that starting a company during COVID was difficult, and this attempts to help those companies with their cash flow. Specially, the government will give “recovery startups” tax credits to help them hire by making hiring new people cheaper.

Qualification tests for recovery startups and employee retention tax credits

There are a couple tests to make sure that your startup is eligible as a recovery startup for these ERC.

• The first one was the business started on or after February 15th, 2020. Basically when COVID hit the United States.
• The second one is the company must have had an average of $1 million or less in gross receipts every year. 

If your company was started in 2020 and you are filing for this in 2021, you’re basically just looking at the 2020 year. Did your company do less than a million dollars in gross receipts / revenue in 2020?

How much can a recovery startup get with the ERC?

So the good news here is your startup can save basically $7,000 per employee on a tax credit, assuming they pay at least $10,000 or more to that employee in the eligible time periods.

It’s capped at $50,000 per quarter. So $50,000 in Q3,2021 $50,000 in Q4, 2021.

How To Qualify for ERTC?

Legacy Tax & Resolution Services (LTRS) Founder, Stephan H. Brewer, CPA, CTRS, JSM Tax, NTPI Fellow provides a brief video overview of the employee retention tax credit and its benefits. LTRS can easily check for its customers whether their business is eligible for ERTC. During the pandemic:

• Were operations partially or fully suspended under government orders due to COVID-19?
• Did your business experience a decline in percentage of gross receipts?
• Are you a Recovery Startup Business that began after Feb. 15, 2020?

Qualified Wages

For quarters in 2020, employers with fewer than 100 employees can receive credits for 50% of wages paid to all employees plus 100% of the cost of employer‐provided health care (subject to per‐employee cap).

For quarters in 2021, employers with fewer than 500 employees can receive credits for 70% of wages paid to all employees, plus 70% of the cost of employer‐provided health care (subject to per‐employee cap).

For both years, employers can’t claim ERTCs for wages that were used in calculating PPP loan forgiveness.

PreAudited For Your Protection

Our process is why we are different from the other R &D processing services. Every single case that we process is “PreAudited.” This means we use the same process that an IRS auditor would use to verify your qualifications for the R & D credit. The IRS R & D Processing Unit only has a limited time to work on each case. They do not have the time for an extensive validation process. While that may be good for your business on the front end, it could be a massive disaster if your business is audited in the future and found not to qualify or qualify for a lesser amount. This could lead to huge penalties and perhaps even a referral to the Criminal Investigation Unit. This is why for every client we process, we PreAudit Every Case. If you are working with a process service that does not have this level of service, We believe you may have a potential huge future liability and not even know it. Processing Services that get paid a commission based on the refund size are incentivized to perhaps overlook things or not verify qualification. And if they are not licensed, wow, you are really taking your chances.

How do you know there are going to be a high number of future R &D Audits?

When firms start advertising R &D Audit Representation Services (ourselves included) the writing is on the wall.  Get ahead of this by only working with a firm that PreAudits your R & D Application.  If your firm did not conduct a PreAudit as part of the application process, consider having us conduct an R & D Risk Assessment.  The best time to start preparing for an R & D audit is before you receive any notiication  from  the  IRS.  If  you  suspect  that  you  may  have been misled by a bad actor R & D provider into claiming credits you were not eligible for, the best thing you can do is seek a second opinion from a professional regarding your eligibility and have an R & D risk assessment conducted.

Here’s How We Can Work Together

Flexible Options in Working With You or Your Team

There are several flexible options to work with you.  The most popular is the Done-For-You (DFY), where we handle everything for you from start to finish.

Done-For-You (DFY)

We handle it all, from start to finish – MOST POPULAR OPTION.

Do-It-Yourself (DIY)

Have us review your work.  We will analyze to determine where your package is lacking, needs correction, or lacks support.  If you have already submitted your application, we will tell you if you have cause for concern.

Done-With-You (DWY)

Let’s collaborate.

Consult-With-You

Customize to your exact needs. 

Legacy Tax & Resolution Services DONE FOR YOU (DFY) R&D Service

Legacy Tax & Resolution Services R&D Service can help businesses retroactively claim the Research and Development Tax Credit.  Your business will receive the following:

• A specially trained R&D expert to review your qualifications
• A report providing complete documentation of all calculations
• Preparation all required forms

Here’s How We Can Work Together.  We break our processes down by the number of employees that you have (1-50 employees and 51- 500+ employees)

Do You Have 1 to 50 Employees?

$0 for the Initial Analysis Fee

To dive in and run the numbers

Analysis Fee Upon Engage

We present your refund amount and quote you a Flat-Fee based on the number of qualifying quarters and the number of employees.  We charge a refundable fee of $2,500, applied toward the remaining balance upon receiving your refund. 

Balance of Fees Upon Refund

The balance of the fees is due within 7 days of receiving your ERC refund check.

In this case, there is no initial fee or risk to you for us to get started and dive in and run the numbers, even though there is still a lot of work on our end.

We’ll have an initial conversation with you and ask specific questions to ensure your business qualifies under the revenue test.  Before this initial conversation, you will have been sent an initial survey to assist with your initial qualification conversation. 

We’ll send you client requests for documents needed to support your application thoroughly.  We will also ask that you complete and sign an IRS Form 8821- Tax Information Authorization that will be used to track your case with the IRS.

It should take you about 10 minutes to gather and upload the required documents via our secure portal,

Our Tax Advisors will methodically determine your eligibility quarter-by-quarter for 2020 and 2021,

Then run the payroll calculations employee-by-employee for eligible Qualified Wages.

We will subtract out any PPP loans, R &D Credits, Work Opportunity Tax Credits (WOTC), Families First CoronaVirus Response Act (FFCRA) Credits, Shutter Venue Operators Grant (SVOG), Restaurant Revitalization Fund (RRF), and other tax benefit programs you may have received from your qualifying wages.  Next, we will remove any disqualifying owners and family members from employee-qualified wages, and the final maximum ERC Refund will be determined.

These numbers are checked 3x’s by 3 separate Tax Advisors to ensure we have the correct and maximum ERC Refund you qualify for.

Our application packages are by-the-book and per current IRS rules and guidelines.  We literally PreAudit every case and provide well-documented support for every application. 

At this stage, we review your ERC Refund amount with you; that is where you can decide if you want us to proceed.

We’ll quote you a reasonable flat fee amount to finalize everything. Our fee is based on the number of qualifying quarters and the number of qualifying employees.

Most clients say YES at this point because we have already put in a lot of work, and our flat fee to proceed ahead to finalize your ERC Claim is less than what most professional ERC processing firms charge.

Then, we take all the work done up to that point and prepare and fill out the correct amended tax return forms to claim the ERC credit and provide the proper support documentation to support your claim.

These amended returns are called IRS Form 941-Xs, which must be filed for each quarter your business qualifies for.  Form 941 is what your company already filed each quarter for payroll, and the 941-X is an amendment to those prior returns.

We will send the final amended Form 941s for your signature and return to our office.  Once we receive the signed Form 941-Xs, we will mate these to the supporting package and forward the entire application to the IRS with tracking.

We will use Form 8821- Tax Information Authorization obtained from you as part of our information gathering to track your case with the IRS.

Upon the IRS’ completion of the review of your case, your business will receive a check directly from the IRS for your ERC Refund.

The balance of the fees will be due within 7 days of receiving your ERC refund check.

Do You Have 50 to 500+ Employees?

$2,500 fee for the analysis

We charge a refundable fee of $2,500, applied toward the remaining balance upon receiving your refund, to dive in and run the numbers.

Balance of Fees Upon Refund

The balance of the fees is due within 7 days of receiving your refund check.

This is how we engage because there’s much more upfront work for companies with more than 50 employees.

The process is the same as listed above, with the only difference being to charge $2,500 to perform the analysis.

We run through the same systematic in-depth process.

To start the analysis, you would be charged an upfront fee of $2,500.

Our Process Steps

Initial Consultation

It all starts with an initial consultation to make sure you qualify for the R & D program.

Checklist

Since we have determined in our initial consultation that you qualify, we will email a simple checklist of documents needed

Upload Documents

It will take you about 10 minutes to gather these documents and upload them to your secure portal.  We take security very seriously.  The details and the bulk of the time will be spent completing the narrative for the 4-part qualification test.  This is where the majority of the time will be spent in creating the supporting documentation.  We will provide very detailed and instructive questions and examples as part of our survey to full support the 4-parts test as part of supporting document for your application.  Once the package is complete, if your are audited, your can feel comfortable knowing your are ready!

Deep-Dive Analysis to Verify Eligibility, Run Calculation and Determine Maximum R & D Refund

Once we get all of the documents, our Tax Advisory Team will analyze your expenses.

We will then analysis your responses to our extensive surveys to support the 4-part test.

Everything we do is thorough and accurate to help you maximize the total R & D Refund you’re legally allowed by the IRS based on your documentation.

Please Note: This is a very simplified description of the process and workflow. However, there are many complex details, IRS rules and regulations, and unique circumstances that determine your company eligibility and total R & D Refund amount. There are some businesses that may not qualify for the Research and Development Tax Credit program after going through this deep-dive process.

Quickly Provide a Preliminary Report

We provide you with a quick preliminary report of the opportunities and then dive in to the details

Analyze The Data

Our experts review your business activities ensuring that all credits and incentive requirements are satisfied, and the appropriate opportunities are identified

Document Credits

Our audit ready final report includes the supporting documents necessary to claim and support each credit or incentive requested

Secure the benefits

We provide your company all the necessary forms and instructions necessary to claim the credits and incentive due to your company.

Monitor the Process Until the Check Is In Your Hands

Through an IRS Power of Attorney we will monitor the progress until the check is in your hands