Lisa Johnson, CPA, Tax Director, FintechForce

NAVIGATING CHANGES IN 2022 BUSINESS TAX CREDIT RULES

How R&D Can Cost or Save Your Fintech Startup in the Ever-Changing Tax Landscape (or Minefield)

Lisa Johnson, Tax Director

Research and Development is a cornerstone of many startup businesses. For over 70 years, businesses have also been allowed to treat their efforts in research and experimentation like any other current trade or business expense for tax purposes. But as of 2022, that changed, bringing with it some good news and some bad.

If you’re a business owner, especially a startup or an aspiring unicorn, this applies to you. As we catch our breath from the end of another tax season, it’s important to highlight recent tax code changes in Research and Development (R&D) and Research or Experimental (R&E) expenses that will likely affect your bottom line.

RESEARCH AND DEVELOPMENT EXPENSES (THE BAD NEWS FIRST)

The Tax Cuts and Jobs Act (“TCJA”) enacted in 2017 introduced significant changes to the Internal Revenue Code regarding R&D expenses for tax years starting after December 31, 2021. These changes require businesses to capitalize and amortize certain R&E expenses over a period of years rather than deducting them in the year incurred, resulting in reduced deductions and thus increased taxable income. Critics contend that these requirements hinder innovation and growth in the United States.

Senate Bill 866, the American Innovation and Jobs Act, was introduced in March 2023 to counteract those effects. It’s designed to promote innovation and job growth in the United States by repealing the TCJA changes in the treatment of R&E expenses.

BUSINESS R&E EXPENDITURES INCLUDE:

  • Creating new or innovative products
  • Improving or redesigning existing products
  • Developing processes, patents, formulas, techniques, prototypes, or intellectual property including software
  • Contracting with scientists, designers, or engineers who engage in qualified activities


NOW WHAT? As of June 2023, this Senate bill is still pending. Generally Accepted Accounting Principles (GAAP) remain the same, requiring the cost to be expensed in the year it is incurred. Tax professionals have hoped for more expedient relief from these requirements, and many requested tax filing extensions in anticipation of changes before the final deadline. That hope is dwindling, and it is mandatory for all businesses to comply with the daunting task of identifying direct and indirect expenses related to R&D solely for tax purposes.

RESEARCH AND DEVELOPMENT TAX CREDITS (THE GOOD NEWS)

R&D Credit expenditures are described in a different tax code section. Classified as Qualified Research Expenditures (QREs), these direct costs are more easily identified than the R&E expenses mentioned earlier.

QREs MAY INCLUDE:

  • Wages paid to employees engaged in, supporting, or supervising qualified research
  • Up to 65% of amounts incurred by non-employees for qualified research
  • Supplies directly used to conduct qualified research
  • As R&D tax credits, they are independent of the changes to R&E deductible expenses and remain a valuable tax strategy, even for companies with limited income tax exposure.


HOW SO? Businesses may elect to use this income tax credit against payroll tax. This is a great opportunity for cash-strapped startup businesses. Eligible organizations who have less than 5 years of generating gross receipts and less than $5 million in gross receipts in the current year could offset up to $1.25 million in payroll taxes.

The documentation and processes for tracking QREs as well as the compliance with the new R&E expense requirements can be overwhelming. IRS guidance continues to evolve on this topic. As with any new tax regulations, it is important to proactively discuss the impact of these changes with your experienced tax advisor.