Renewed interest by financial institutions, focused audits by the IRS and expanding State benefits
Having had a year to digest the monumental changes made to the U.S. Tax Code by the Tax Cuts and Jobs Act (TCJA), it’s now time to turn the focus on the future and examine whether the taxpayer victories of 2018 will continue.
As we enter 2019, I am happy to report that the IRC Sec. 41 Research & Development Tax Credit has been preserved. Some issues still remain unresolved when it comes to qualification and quantification, but overall we here at TCG believe the R&D credit will continue to be an important tool for helping U.S. businesses stay competitive in the global marketplace.
With that in mind, here are my top 3 R&D tax credit predictions for 2019:
1. Many Financial Institutions Will Begin to Claim the R&D Credit
On October 4, 2016, the Treasury Department and the IRS published final regulations relating to Internal Use Software (IUS) development under Internal Revenue Code Section 41 relating to the research credit. Based on the new favorable guidance outlined in the final regulations, taxpayers who were once limited by the additional scrutiny of the high threshold of innovation test will now have new opportunity to reconsider the credit.
Armed with these regulations and a permanent credit, taxpayers conducting software development are now in a much better position to plan for and document research credit claims. These final regulations continue a recent line of “pro-taxpayer” legislation, regulation, and court rulings relating to the research credit, which will allow for the expanded utilization of this incentive and reduce the controversy that has historically plagued taxpayers who have claimed it.
Financial institutions will especially see greater opportunity to claim R&D credits for their investment in customer-facing software applications. Pursuant to these regulations, investment in the design, development, and implementation of client systems such as online banking, online investment services, web-based insurance quoting services, and mobile apps, may now face fewer qualification requirements for credit eligibility. In addition, the new regulations provide for a more favorable definition of the three requirements that make up the high threshold of innovation test for IUS and the process of experimentation test to which all software development is subject. Given this clarity and now, the ability to plan the preparation of requisite supporting documentation, taxpayers should now have a better chance of sustaining credits claimed for any type of software development activities.
2. The IRS Will Continue to Audit Credit Claims, But With a More Focused Methodology
With a new commissioner and budget finally in place, the IRS is set to head into 2019 with many challenges to face. While coping with a tight budget, the tax agency must continue its mission of collecting taxes and enforcing our tax laws while implementing the new technical and process changes required by TCJA, updating an antiquated IT system, improving taxpayer assistance, and finding the staff to support these efforts.
In addition, new commissioner Rettig’s overriding goal will be to strengthen and rebuild trust between the American people, the IRS and Congress. In line with this goal, the commissioner has pledged transparency within the IRS. Specifically noted is the increase in publication of internal IRS training manuals.
Regarding compliance initiatives relating to the research credit, we should expect to see a more focused approach to audits. Specific areas of potential non-compliance may be addressed, as the IRS identifies these issues, in a more coordinate and consistent manner. For example, the provisions added by the Path Act of 2015 relating to payroll tax and Alternative Minimum Tax offsets include specific requirements for eligibility. We could expect the IRS to examine compliance of these requirements using template questionnaires and document requests, to efficiently address any potential issues in a coordinated manner. This coordinate approach would help to ensure consistent treatment of taxpayers and uniform disposition of cases.
We should also expect to see the IRS issue taxpayer guidance addressing these issues. The IRS has been proactive lately in issuing notices to provide interim guidance to taxpayers where the tax code or treasury regulations have left gaps in how to implement new provisions or where clarification of technical requirements is necessary. By providing this guidance, the IRS can increase taxpayer compliance without the need to expend limited resources.
3. State Credit Benefits Will Continue to Expand
A majority of U.S. states provide for a tax credit for research and development. As the competition between the states for economic growth and new jobs continues, so will the need to provide tax incentives such as the R&D credit. Recently, we have seen many states extend credit provisions, add new methodologies, and improve upon calculation methodologies. We should expect to see these efforts continue in 2019.
Although most states use Section 41 of the federal IRC as a foundation for their own credit statute, state specific provisions are common. Depending on the state, there may exist unique eligibility requirements, credit amount caps, calculation methodologies, and utilization limitations. Each state is looking for a credit formula which will entice a business to locate or relocate within its borders, which the state can actually afford.
Going into 2019, we can expect states to continue to measure their particular credit’s effectiveness in comparison to the other states, and adjust the formula if necessary. Expected improvements include making the state credit permanent (as the federal government had done in 2015), increasing annual cap amounts, making the credit refundable or able to offset multiple taxes, and adding simplified calculation methods (such as the federal Alternative Simplified Calculation methodology). In light of the fact that 2019 follows an election year that resulted in significant gubernatorial and state legislature changes, we should expect to see these improvements considered as the newly elected state officials take control.
So there you have it—my 3 R&D Tax Credit predictions for 2019. If and when these predictions come true, you can be sure that we’ll provide you with updated information right here on the R&D blog. Be sure to Subscribe Here.
Michael Krajcer is President of Tax Credits Group. He has specialized in the R&D Tax Credit since he started with the IRS in 1986 and was a Cleveland large case technical specialist on the issue. Subsequent to his government career, he continued as an expert in the credit area in Big-4 accounting, industry, and with his own national practice. Mike has worked with hundreds of companies throughout the United States and has resolved dozens of IRS and state audits of credit claims.