Q1 estimates and impact of 174 changes, February 2022 

174 CONSIDERATIONS FOR Q1 ESTIMATES 

Companies Need to Be Prepared for Upcoming Changes 

The Research and Development Credit (R&D) has been a popular tax credit for years.  In taking the credit, the vast majority of companies have taken immediate expensing of the expenses that are deemed qualified and gone on with the filing of company tax returns.  With the Tax Cuts and Jobs Act (TCJA) that was passed in 2017, a change was made to how taxable income is calculated if the R&D credit is taken.  Starting with the 2022 tax year, all expenses utilized in the R&D credit will now have to be put into section 174 and amortized.  This will change companies’ taxable income and require more tracking of expenses.  Additionally, this will have an impact on what needs to be disclosed on quarterly filings for publicly held companies, and privately held companies should consider this change in forecasting results. 

This IRS rule change will require a change in accounting method so that will have to be disclosed in financial filings.  Upon this change all domestic research expenses are required to be amortized over a five-year period.  If there is any foreign research, those expenses are required to be amortized over a fifteen-year period.  This most likely will be the biggest hit to companies who develop software and outsource some of the work overseas.  That topic will be covered in detail in another article from CFO Services. 

The good news is the change to taxable income is on the tax side and will not have as big of an impact on financial statements and valuation.  There will need to be disclosures to investors, stakeholders, and owners that taxable income will be impacted, and it will require additional planning and resources.  So, the company will need to file Form 3115 – Change in Accounting Method to begin the capitalization and amortization of the expenses, but no section 481(a) adjustment should be needed, though the IRS has still not issued guidance on the issue.  The bigger issue is the administrative burden of creating and keeping up the amortization schedules as well as being more diligent and recording more detailed information with regard to the expenses.  In the past, foreign research expenses have not been part of the R&D credit study because those expenses were not able to be qualified for the credit.  Now, under 174 the expenses must be tracked and amortized over the fifteen-year period.  Where this could impact financial statements is if the additional work requires additional administrative costs.  This could include having to hire additional staff or require outsourcing some of the work to contractors or consulting firms. Time will need to be spent with outside vendors to determine what work is being done overseas, and whether it can be broken out between design and maintenance activities. 

Some company owners or investors may want to know the impact this new regulation will have on the company tax return.  The tax provisions that get prepared should start to incorporate these new regulations.  The best way to start this process is to take the prior year credit study and make the calculation changes for the differences between Section 41, the R&D research credit, and Section 174.  Under Section 174 there is no substantially all rule, so any wage expenses need to be taken at the specific amount that was qualified. For example, if an employee was qualified at 85% for the R&D credit study then for the credit they would appear as being 100% qualified, but under 174 the wage expense would be 85%.  Additionally, contract research under Section 174 does not have a “hair cut” to 65% of the expense, so that will need to be adjusted to determine the 174 expenses.  The hard part will be determining the amount of foreign R&D expense since that has likely not been tracked in prior years.  Estimated tax that must be paid will be higher than in previous years due to this amortization of expenses. 

The Build Back Better bill that failed to pass Congress did have a provision within it that would have pushed this change out another five years.  Depending on what happens over the next couple of months there is a slight chance that it could be taken up apart from the bigger bill, but this is not likely.  So, start planning and putting systems in place now.  CFO Services can assist in this process as you calculate your new quarterly tax provision. 

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. Overall:  CFO Services provides companies with services to identify and secure federal, state and local incentives across the United States 
  • Specialities:
    • Federal/State R&D Credits:  Helping clients with the R&D credit calculation, documentation, and exam for creating or improving the product/process. 
    • Multi-State Credits & Incentives:  Collaborate with our clients to capture statutory and discretionary state incentives. 
    • Technology:  Both areas of service utilize proprietary technology to streamline the capture, compliance, and management of a client’s business incentives. 

IRS CircIRS 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. 

Establishing a Business Incentive Program, November 2021

PART 1: WHY DEVELOP A BUSINESS INCENTIVE PROGRAM?

Why should an organization establish a program to harvest business incentives? That question is more easily answered by understanding how capital is acquired. Money may be obtained through earnings, savings or being awarded or gifted funds. Throughout lives, people work to earn money, accumulate it for goals and retirement or are often gifted wealth. Similarly, businesses use enterprise to profit or financing to acquire the necessary capital for additional investment and operations. Businesses conserve capital several ways. Engaging in enterprise alone will reveal cost efficiencies through the operational process and its experiences. Additionally, the utilization of a new technology or a deliberate strategy may be employed to generate cost savings. But when and how are organizations granted funds? Established within federal, state, and local legislation, there exists numerous tax credits and benefits organizations may claim or apply to utilize. Upon completion of governmental programs and objectives, businesses gain the use of tax credits. These are acquired by meeting the terms of a qualified incentive program. These tax credits may reduce a company’s taxes by granting it the allowance to deduct all or part of certain expenses from its income tax bill on a dollar-for-dollar basis.

Business incentives are regularly available to qualifying enterprises. Many programs provide tax credits just for hiring new workers that range from $1,000 to $5,000 per associate. However, newer programs are using alternative methods to generate benefits. For example, one of these more recent programs partner with many of its state’s community colleges to train new associates for nearby businesses. The community college administers the training, along with a bond issue that generates the necessary funds to pay the cost for the new associates’ education. Once the company hires the newly trained associates, the withholding tax for the new employees (typically required to be remitted to the state) is partitioned and used to pay down the bonds that were issued for instruction. By attainment of this incentive, the company received the funds necessary to train its new associates with zero out of pocket costs.

Locating Incentives

Harvesting business incentives is a continuous strategy to reduce or eliminate out of pocket expenses and capture resources currently going unused by a firm. Determining the number of incentives and potential benefit amounts to be received is an essential step towards a comprehensive incentive project. This “research” comprises the initial phase of the overall incentive progression. Future steps include tracking milestones the organization has accomplished toward the incentive, meeting the ongoing compliance obligations and communicating with governing bodies for clarity. Research evaluations should occur to establish which options are viable and attainable. This involves understanding the incentives extended to the organization by researching the details, metrics for compliance, schedule of filings and any additional nuance the programs may contain.

The first step is to catalog all incentive programs that are outstanding. The list should include details about the program itself along with what agency administers the program, the conditions needing to be met to attain the benefit and how long after attainment that benefit can be used (carryover provisions). A great place to begin the collection of existing packages is via the states’ department of revenue or equivalent taxing agency sites. These sites will contain summaries of the various programs the states and local governments have enacted. Governmental sites will list all present programs, including those currently in force but unavailable to new applicants. Since most states’ department of revenue oversee these programs, they often retain the details or compliance procedures for their outdated programs.

State and local administrations regularly update programs or amend the specifications. Take special note of any application deadlines, program end dates or carry over cut off. Governmental sites will often list representatives who may be contacted for additional information or to answer any questions. These individuals may originate from the department of revenue itself or stem from a supplemental agency (like workforce or economic development).

Who can help?

Affiliate state and local agencies are another useful resource for information pertaining to incentives. Economic development agencies and area Chambers of Commerce have personnel well versed in the specifics of state and local incentives. Many directors at economic development bureaus are connected to and foster legislation to advance business incentive bills. Due to their familiarity with their state and programs offered thru it, economic developers make great resources for examining opportunities.

These contacts can become vastly valuable especially when attempting to select the most appropriate programs for application. Assisting to comprehend the various requirements necessary to achieve benefits and various filings mandatory for compliance are other areas of their expertise. Economic developers often act as liaisons between the organization and the programs’ governing body. They also maintain a network of and familiarity with industry consultants who can assist, represent, and lead efforts for companies pursuing business incentives. Industry consultants are specialized business incentive specialists and can support every facet of the incentive harvesting process. Researching, vetting, and managing the overall process are all functions consulting firm will perform on behave of the companies they represent. Economic developers will often refer companies seeking expert assistance to a consulting service within their area.

Another group who also works closely with consultants and legislature on business incentive programs are Workforce Development Agencies. Since many incentive platforms earn tax credits based upon the hiring of new employees, workforce developers maintain the knowledge necessary to assist with pursuit of many “New Job” programs. Workforce developers leverage their extensive network of connections to better assist companies in acquiring benefits. Many of their ties include faculty from community colleges and agents within job placement services. Workforce developers can be greatly impactful with locating job incentive programs, finding qualified new employees, coordinating with community colleges for training and finalizing the process by placing workers into jobs with applicable companies.

Finally, technology and data services exist that will query thousands of incentive programs and filter to the criteria that organization prefers. These technology firms have released web-based applications that make searching the thousands of programs much easier and quicker. Once programs have been identified, the vetting segment of the initiative begins. Communications with representatives from the Department of Revenue or other governing bodies will uncover intricate details necessary to comply with the nuances of the incentive program. This step is immensely imported to ensure outdated incentive plans are filtered from the results.

Ultimately, whether technology services or Economic Developers are leveraged, the purpose of any incentive initiative is to locate and utilize all available resources accessible to the business. The expense of locating qualified labor and capital investment can be reduced or eliminated by initiating a business wide incentive program.

In Part 2 of this segment, “Implementing a Business Incentive Program”, a description of the logistics behind planning the initiative will be covered. The next phase of this article will provide a blueprint of internal and external resources necessary; a description of staff needs to facilitate the effort and decisions businesses will encounter throughout the course of their incentive exercise.

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