What’s new for R&D Tax Credits in 2023?
The last year or so has been a tumultuous time for organizations around the world, from a stuttering “return to normal” as the pandemic has settled to a low roar in many parts of the globe, to a world economy that is yet again “unprecedented” in its behavior. As a result global financial markets remain volatile, the era of “cheap capital” has come to a screeching halt, and yet supply and labor shortages still put pressure on corporations to do something in order to ease shareholder concerns. The icing on the proverbial cake is that U.S.-based tax legislation is changing in 2023 in a manner that holistically alters how businesses will recognize R&D expenditures. The change in the code was specific to Section 174 of the U.S. Tax Code and impacts both how organizations claim the Section 41 Research or Experimental tax credit, and how those organizations treat the expenditures. The difference in tax treatment – both from the Section 41 R&E credit and whether or not the expenditures are expensed or amortized and capitalized over time – change organization’s expected net profit and loss statements and overwhelmingly impact businesses that focus on research and development.
Many outlets are reporting on this change, but what does this exactly mean? In a number of posts by both Jellyfish and Neo.Tax, we outline exactly what has changed with the process of accounting for R&D efforts in order to appropriately expense, utilize for tax credits, or capitalize those costs. The sunsetting of policies that allow companies to immediately expense a significant portion of R&D costs instead forces companies to amortize them over a set amount of time — 5 years for domestic R&D and 15 years for foreign R&D. The tl;dr takeaway is that companies that are currently unprofitable from a GAAP perspective will begin to look on-paper tax profitable and will be hit with hefty (and unexpected) tax bills this April. For larger corporations, the changes will vastly raise your taxable income, which can lead to a 4x-ed tax bill!
This change in tax legislation has proven to be broadly unpopular and has sent many of our friends in corporate finance roles into an anxiety-ridden state to account for how different the finances will look. For us here at Jellyfish, we won’t necessarily state that this is either “good” or “bad” for organizations as a whole, but it does introduce a significant amount of change and will introduce new finance and audit processes as R&D-focused operations adapt to these alterations in reporting. It fundamentally modifies the status quo and for teams and companies that are already dealing with pressure coming from all sides of this new paradigm, such modifications may not (understandably) be welcomed with open arms.
The shameless plug that we have for you, astute reader, is that while new processes and changes are not necessarily viewed in a positive light, there are effective strategies to ease the transition and ensure a greater degree of confidence that R&D-focused organizations are taking the right steps to ensure optimal financial reporting and outcomes in an accurate and timely manner.
As is the solution with many speed bumps established in current workflows, automation and enlisting the help of capable and knowledgeable partners is key to overcoming limitations of an organization that’s been thrown a curveball. Regardless of how the balance shifts from being able to expense R&D efforts versus amortizing/capitalizing them over time, the critical foundation of any automation initiative will be to both accurately and precisely calculate the aforementioned R&D effort. Ensuring an accurate basis of understanding for where costs are being allocated in different parts of the engineering process is the first step in being able to answer many finance-related questions about product and engineering, a major part of which is the tax liability breakdown for engineering effort.
A consistent, solid basis of data hygiene allows for solutions such as Neo.Tax to interpret and make recommendations about the tax treatment of that data, ensuring compliance with the new R&D capitalization rules. The ability to automatically generate and trust the data coming from your R&D effort calculations makes claiming R&D tax credits or capitalizing those domestic R&D efforts paves the way for significantly less manual work in both processes, hopefully relieving our compatriots on the finance and accounting teams of at least some of their anxiety throughout this tumultuous time (although they’re still going to come after you about submitting expenses late). And because the tax-law change has made the how and where of your R&D expenditures hugely consequential (R&D spend that doesn’t pass the IRS’s 4-Part Test is now 10x as expensive on Tax Day), having a 360-degree of your R&D spend can vastly expand your runway. Tax strategy has never been more important.
- The tax code is changing, for better or for worse.
- You need trustworthy data to understand engineering costs and determine what should be capitalized/amortized.
- New solutions can ensure automated, trustworthy data and make recommendations to ensure tax optimization and compliance.
- Jellyfish and Neo.Tax are here to answer your questions about ALL of this.
To learn more about automating R&D cost reporting, check out Jellyfish’s DevFinOps solution for effort calculation, and to alleviate worries around ensuring that you’re optimizing your tax strategy, Neo.Tax would love to have a chat with you.