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Giving Credit Where It’s Due

Utilities will gain from new regs for research tax credits.

Fortnightly Magazine - April 2005

more test they must meet before they are granted tax credits for their R&D efforts: This is the "substantially all" requirement. We believe that the "substantially all" rule in the final regulations may create additional opportunities to enhance credit-eligible expenditures through the inclusion of costs that are deductible under Section 174 but that don't meet all three of the additional tests under Section 41: design costs, patent costs, and other nonqualified, Section 174-eligible costs. As an example: An engineer's time to reverse engineer a competitor's product. Unfortunately, this provision may also require more work on a taxpayer's part. As is common in the area of tax legislation, there is a bit of uncertainty surrounding the "substantially all" requirement.

Clearly, a company's response to the rule changes will depend on its current tax position but in every case, timely response is critical:

  • Companies that currently are taxable should take immediate steps to ensure that they are claiming the right amount of expenses possible for this credit.
  • Alternatively, businesses whose credits are currently being examined by the IRS should make sure that any disallowances proposed by the IRS reflect these recent developments.
  • Finally, in situations where losses preclude a company from paying taxes currently, management should still take immediate action to document the right amount of qualified expenses.

In sum, as with the administration's new American Jobs Creation Act—as well as for most other recent tax legislation, for that matter—the current rule changes to the tax treatment of R&D expenses present a mix of challenges and opportunities.