Covid-19 Issues with Research Credit, June 2021

The research Credit and Covid-19

Covid-19 has impacted almost every part of people’s lives.  This includes the business world where organizations have had to limit operations and, in some cases, either let people go or furlough employees.  These measures that businesses and organizations had to make will have a significant impact on the Research Credit. 

In order to combat some of the hardships businesses and employees were experiencing, the federal government passed the Paycheck Protection Program (PPP) as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act.  This program was designed to provide an incentive to keep employees on the payroll.  The PPP were low interest rate loans that had the potential to be completely forgiven if certain criteria were met and were structured as having either two- or five-year maturity period.  If the funds were used for payroll costs, interest on mortgages, rent, and utilities, and at least 75% of the amount had gone to payroll then the loan would be forgiven. 

Deductibility of PP expenses

If the loan is forgiven, then the expenses used came from PPP funds should still be included in the Research Credit calculation. Initially based on the April 30, 2020 IRS issued Notice 2020-32 to provide guidance regarding the deductibility for federal income tax purposes it was thought the PPP funds would include some risk to the R&D credit.  The notice stated that no deduction was allowed under IRC for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan, because the income associated with the forgiveness is excluded from gross income.  It goes on to reference Sec. 265 as the specific disallowance provision and notes that case law would disallow the deduction because the taxpayer has reasonable expectation of reimbursement for the expenses. Since this initial determination Congress passed the Consolidate Appropriations Act[1] which allowed the full deductibility of ordinary and necessary business expenses that were paid and forgiven with a PPP loan.

Planning for employee expenses

Some foresight and planning to determine what potential qualified expenses were funded by a forgiven PPP loan would be a beneficial exercise.  One Covid-19 issue that will take extra investigation is how employees were categorized during any office or business closures.  The way businesses and organizations handled employees during this difficult time varied but for the most part fell into one of a few categories.  Those categories would be: employee was laid off or furloughed with no pay or work duties; employee was paid to work from home; employee was paid but not required to fulfill normal job duties or only limited duties; and finally employee was considered essential and had normal work throughout the pandemic. 

The biggest items to review are if an employee is qualified for the Research Credit and how that employee’s pay and job duties were affected by Covid-19. Some employees who typically would be considered to have qualified activities in a normal year may still have been paid to work at home, but not able to do the same types of work as a typical business year.  This scenario would result in the employee’s qualified percentage being lower for the year and result in lower wage QREs.  Another scenario could be an employee was laid off or furloughed for part of the year.  With no pay the employee would not count that time as part of the work year, so there is potential to keep a stable qualified percentage of time.  The IRS has not come out with guidance for these various issues but based on the current regulations and how paid time off is treated it is safe to assume the same would apply to breaks in work for Covid-19 related issues.

The 2020 tax year will be a more difficult year to understand and develop a tax plan.  These issues will need to be accounted for as taxes are filed. Proper planning and expert help can allow for the best tax position for each business. If you have more questions related to Research Credit, please contact CFO Services.

CFO Services Can Help With Your Research Credit & Tax Incentive Needs

The R&D Credit provides an opportunity to reduce tax liability. In order to maximize the R&D Credit impact to don’t forget to capture all the expenses that should qualified, especially wages that are direct support.  To learn if you’re eligible for the R&D Credit or have more questions related to qualified direct support, please contact CFO Services.

Through knowledge and perspectives gained working with virtually every industry and type of client (Fortune 500, medium-size and small companies), CFO Services has committed to a strategy of providing a depth of knowledge in a narrow field of focus: business incentives and credits. Providing tried and tested methodologies, our professionals can help almost any business research, identify and comply:

  • Research and Development Credits
  • Multi-State Tax Incentives and Credits
  • State Sales and Use Tax
  • Strategic Alliances
  • Workforce Training

IRS Circular 230 Required Notice‐‐IRS regulations require that we inform you that to the extent this communication contains any statement regarding federal taxes, that statement was not written or intended to be used, and it cannot be used, by any person (i) for the purpose of avoiding federal tax penalties that may be imposed on that person, or (ii) to promote, market or recommend to another party any transaction or matter addressed herein.

[1] P.L. 116-260 Consolidated Appropriations Act, 2021 [12/21/2020] 276(a)(1)(i) ‘(1) no amount shall be included in the gross income of the eligible recipient by reason of forgiveness of indebtedness described in subsection (b),

(2) no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided by paragraph (1), and”