Streamline your sales audit procedures for Research and Development with airSlate SignNow

How to create outlook signature

foreign we have an excellent lineup for you today and we will be offering one hour of CPE looks like our audience is continuing to grow so we have an impressive group of people joining our session today as well let's go ahead and cover some of the CPE items before we get going to receive CPE credit you must answer at least three of the four polling questions and attend for the full 50 minutes now those CPE certificates will be issued via email within 10 days if after 10 days you haven't received one you can email cbh learning cbh.com a recorded version of the webinar will also be available in about a week it'll be posted to our website and sent out via email now if you have any questions during the webinar go ahead and type those into the Q a window that is located down at the bottom of your control panel and one last thing a short survey is also going to be posted at the conclusion of the session we value your feedback and just ask that you take part okay Sarah I'm going to go ahead and turn it over to you great thank you Maddie and Maddie will be here to handle all your uh technical q a and issues and I'll be here to watch the chat pod and the questions pod to field your questions to our presenters today I'm delighted that Marty Cameron is joining us he is a partner in our tax credits and incentives advisory practice he's the leader for our for that group uh Vivian Coors and Corning Pearson are both directors in our credits and incentives group and they bring a lot of experience to the table we've been having conversations about section 174 and its impact for quite some months and uh and also dealing with it directly with clients so they bring a great level of experience here to this conversation uh I'm Sarah McGregor I'm a director in our tax practice and uh I've been thinking about this and the impact to taxpayers and how it works for them so this is going to be a great program I I think that is enough for my side so Marty I'll go ahead and turn it over to you well sorry I think we have our first polling question uh that's up first so Maddie if you'll go ahead and bring up that polling question so just a real quick get you used to answering the polo questions see what they look like coming let us know how uh you were heard about this webinar that would help us to know what you're hearing foreign just a minute there I think today's program is you know when there's not a lot of IRS guidance out there the people taxpayers either flourish or uh flounder and we hope that by the end of today you'll be able to flourish a little bit even in this uh period of uncertainty about how all this section 174 works okay many are we a good place to to move forward I'm going to keep it open for about five more seconds for those who are just joining us so if you see a poll go ahead and answer it we're going to shut it down here in a couple seconds right okay votes are in all right Marty I think you're up to to give us a uh where we're going today yeah I'll set the table as they say thank you Sarah So for anybody who's on this um as you're probably aware as part of the tax law changes enacted in 2017 under what was known as the tax cuts and jobs acts basically tax reform that took place back in 2017 that kicked in in 2018 uh beginning in 22 specifically for tax years ending after 131 2021. Congress now requires taxpayers to capitalize research and experimentation expenditures uh and they Define them as 174 costs and you have to capitalize them and now amortize them either over a five-year period with a mid-year convention or a 15-year period with a mid-year convention depending on whether it is a domestic expense or a foreign expense respectively this varies differently and radically from the Old Law um where prior to 22 these types of what we'll call 174 expenses expenses in the research and experimental uh variety um you could expense them uh you actually have flexibility you could you could expense them immediately or you could a juicy either amortize them over five or ten years depending on the utilization of some other um some other tax codes uh additionally uh in 2022 um the tax cuts and jobs act also specifically added software development uh to the definition of RNA expenditures under Section 174 so as a result um all software development costs must now be capitalized as well as amortized and that's whether or not the software is intended for internal or um or external use Corning is going to cover this a little bit but the IRS did get out some guidance on this specific to changing your accounting method this is obviously important because your accounting method change requires permission um from expensing to capitalizing and amortizing it was made clear that if you do this in the first year that it you're required to 2022 you get honor protection for the priorities and you don't have to file a 3115 So Courtney will get in some of that later um in terms of additional guidance right now the IRS is working on procedural guidance but it's not doing it particularly quickly um you know the some the basic questions of what does capitalization mean um you know which expenses qualify is there a diminished misconception how does it differ from the research credit these are the questions everybody's asking and it's some of the stuff we're going to address today um but it's not a real high priority for them right now uh and so I don't expect anything to come out before people have to make estimated payments or potentially um file um there's not a lot of case law in this matter in this area as well because it really didn't matter that much because it wasn't too different from a 162 expense people could automatically uh deduct it so the guidance is spare but we have some rules of the road that we're going to share with you today um and you know everybody's hoping that Congress gets their act together a little bit and potentially addresses this by um putting it back to the way it used to be um and there there is hope and there is both by pardon there's bipartisan support for that having a vehicle to attach that to and having Congress actually get together and vote on something in a collaborative way I think we won't hold our breath immediately right now but um but that's where we are and I just want to thank everybody for joining today and we're going to talk about the legal framework and all these all these areas right here uh and very I also just want to say I'm very um impressed with my directors who are playing this together Vivian and Corning and also with the support of my partners Ron Wainwright and Dan metal as well um we've been talking about this every day uh internally in our little working groups and also with clients and also to some other firms as well just to see what's going on so we're well informed and we thank you for joining all right so we'll talk about the legal framework a bit and and then I'll hand it off ing in a moment but um as you can see what what's on this slide isn't much more than there is actually in the statute for 174 174a talks about you know your requirement to capitalize and amortize specific RNA expenses charge them to a capital account and again that rule about domestic expenses are amortized over five years using a mid-year convention four in 15 years using a mid-year convention sections 174 B and C just talk a bit and Define specified uh RNA expenditures which is a little bit um further uh illuminated in the regulations but research experimentation expenditures are those which are paid or incurred by the taxpayer during the year in its trade or business software is by definition a 174 expense software development um we've been doing some analysis as for companies that work in software is it true development they're doing or is it something else that's something we can talk about a bit as well 174c just has some very special rules um about some areas that aren't maybe 174 as well land buildings and equipment and tangible assets are not research experimentation depreciation or amortization maybe and maybe charge to a capital account and exploration expenses are accepted from the definition so they would not be included as a 174 expense in the regs it talks a bit about like the definition of of research and experience research and experimentation expenditures um and again those are those expenses incurred in connection with the taxpayers trade or business which represent r d in the laboratory sense generally speaking it's those activities they're intended to eliminate some uncertainty either with respect to the capability of getting something done or the method by which uh that gets done it includes and this is this is why it's so broad all costs incident to the development um of the Improvement of a product um it's an activity-based test so we look for what the company or the taxpayer is doing not the nature of the product not the level of technical advancement but really whether they're addressing uncertainty and those then those expenses associated that would be um research and experimentation 174 expenses success failure sailor use of the product process is not is not relevant um and can be post-production if there's uncertainty as well you probably are familiar with some of these Concepts if you're claiming a research credit um it's an interesting allegory it's close but these are Big larger group of costs that would go into uh into the analysis why don't we move on okay and just within the regs there's uh some examples basically obtaining obtaining a patent you know attorney fees uh with respect to making it perfecting a patent application would be included it does not include fees for defending existing patents products can include include pilot models processes formulas inventions technique patent or similar property um and again exclusions we're always thinking about what's in is the uncertain type of activities what's out the exclusions are ordinary quality control testing efficiency surveys management studies advertising promotion and again acquisition of existing patents models production methods and processes so hopefully that sets the tone a little bit we're always focused on those activities that are specifically intended to eliminate uncertainty um but it can be a broad number of expenses all right ing why don't you take it away and talk a bit about some of the administrative guidance great thanks Marty um if there is a underlying theme here it is sort of a lack of guidance well Marty just went over really is the qualitative guidance that's come out um whether it's the new statute there are some coordinating uh elements that have been changed to 41 and 280c as well um that were just required in order to do this but if we need to look beyond that we're looking towards um administrative guidance that already is an existence case law that was covered under 174 previously so you kind of enter into a almost a Bizarro world where the taxpayer positive guidance where they were seeking to get things categorized as 174 in order to deduct them now gets treated as 174 is required to be allocated so that's one thing to be careful as you're looking towards guidance outside of the statute outside of the pertinent direct regs that pertain to this the IRS in late last year put out the Rev proc it's an administrative guidance towards um towards filing your tax return amended it in the middle of January with rev 2023-11 which is the latest guidance that we have on that um this is sort of a teaser for a little bit more granular detail later but just know that this is a accounting method change you are not required to file a 31-15 if you're filing timely on a timely or extended return for the first year uh that you have pertinent expenses after December 31st 2021. it is a cut off method if you're filing on time in the first year um no 481a adjustment is required if you are filing late if it is the second tax year in which you have expenses after 1231 2021 you are required to file at 31-15 and there will be a catch-up 481 a we'll go over a little bit where some of those cases might occur in the instant time for short tax years early in 22. so basically that's the only Guidance the IRS put out as Marty said we're promised more later but as we go on we're we do have experience in this area we tax we as taxpayers and taxpayer Advocates so we can rely on some of the guidance in other areas that are similar to this okay right yeah we're up to our second polling question so did your company incur section 174 research and experimentation expenditures in 2022 uh give us your thoughts on that tell us what you think uh right now that um if you have those uh or if you or did not or are not sure so we'd appreciate that and uh Marty already a couple of uh questions have come in if I can uh give throw one to you so you mentioned software uh software development uh is is that just for internally used intended use software or for external use uh and Licensing outside of the entity as well you'll find that my answer is always going to be as expansive as possible to any of these questions so it's both honestly it's it's it's a broadly defined software development expense there are some other rules out there and a Thing Called Red prop 2050 that differentiates between software development from software configuration from maintenance and support So when we're thinking about software development we're not necessarily concerned with whether it's for internal or external use we're more concerned with what are they actually doing from a software development perspective and is it true development and can it maybe be carved away into a different category on activity great all right and one more uh you guys have had great success in helping uh say uh a e firms architecture and engineering firms find research uh tax credits that could benefit those organizations so it would also uh seem likely that these organizations even though their personal service they would also uh potentially have section 174 research and experimentation costs as well expansive answer again and absolutely so and I think you bring up a good point here it's that this is not related to the research Credit in the sense that if you don't claim a research credit you still have to go through the uh identification of whether or not you do or do not have any section 174 um expenses and you know we've had some early conversations with taxpayers where they've indicated okay well maybe I won't claim a research credit this year so I don't have to do this it doesn't work unfortunately so um we will always look to the nature of the activity and so yes Sarah you're correct all right Maddie urea pretty good on the question can we go forward now we are I'm going to go ahead and share those results right now absolutely so it looks like uh people are all all across the board there for in thinking about uh where they are with with Section 174 costs uh Vivian I think you're next to to talk to us about some of the Practical approaches and ways of thinking about how we find these costs I know so we talked about this before this this is a broad kind of research and experimentation catch-all bucket of costs right so how can we provide some guidance to for taxpayers to look at their books to look at their costs and try to capture those costs at least to figure out what the potential impact is to their taxable income so suggesting suggested approaches are kind of listed here but I would just kind of broadly say hey put on your 174 hat and kind of think about what costs are incidental to my development would it be the cfo's time because in in theory they're running the entire company in a portion of that company is doing r d so the CFOs costs are in support of development and incidental to development so just kind of think about things they are broad they are meant to be broad um so to the extent that your company has previously claimed an r d tax credit and are claiming on our new tax credit for 2022 I would suggest that that would be a good starting point for you to start identifying your section 174 expenses because 41 expenses are are kind of like your core 174 costs also it's important to kind of review your actual activities the section 174 is an activities based analysis so look through your contracts kind of understand what are you providing if you are a professional service provider to your customers or if you have developed your own software your own product your own processes just understanding those activities and where those costs are located um look at your internal budgeting if you follow ASC 730 those would also be great points to start and to the extent that you have already capitalized costs for book accounting when you're looking at your GL accounts to find research and experimentation expenses don't forget the cost that you already capitalized just in case um those would be generally 174 but I would say 174 it's much broader than AIC 730 it definitely broader than just section 41 r d tax credit costs um so General approach would be start with your GL expenses so to make sure you're not missing any of those costs and go through account by account to kind of identify okay yes this uh the salary amount for engineers are definitely related to R D but I would suggest you take a step further right because our truly all of those Engineers spending a hundred percent of their time addressing technically challenging processes or product to design questions probably not so that would give you a segue to carve out the costs that are not necessarily research and experimentation in nature um also there are definitely definitely General and administrative type costs and departments where it would be important to figure out what is a reasonable way to allocate those costs to research and experimentation activities um understanding that hey there is no technical guidance around this as of right now but as long as it's reasonable as long as it kind of matches your facts and circumstances I would say that that would be a good approach to start with and it's important to clearly document your methodology um so that you could create a repeatable and defendable process in the event of an audit so maybe it is by that GL account approach you look at certain accounts you establish hey year over year this is pretty similar that this is always going to be travel entertainment for marketing department that would probably not be r d so nothing that you need to just making sure that you document that would be an important start um and then make sure that you're separating out your onshore and offshore costs to the extent that your general ledger accounts aren't set out to capture that make sure you're digging through the detail by vendor or if certain vendors have half of their resources onshore half of the resources on offshore make sure that you're documenting that and capturing just the appropriate amounts so that you can capitalize and amortize ing to whether it's an onshore activity or an offshore activity um and again making sure that you're not missing anything or applying to Broad stroke of an approach that would either overstate or understate your section 174 costs um lastly you would have to summarize your section 174 costs in the in your disclosure statement for your 2022 tax year um or the first tax year after December 31st 2021 um so just make sure that you're capturing those costs appropriately you know Vivian this sounds a lot like a section 263a kind of analysis I mean that's absolutely without further guidance it seems like the kind of approach you want to take uh but maybe not being so uh so well defined absolutely so when you kind of think about unicap and your square footage approach maybe that would be a great starting point for some of the rent and utilities that you are trying to allocate to your research and experimentation activities so thank you Sarah for bringing that up now on Section 174 costs where you are trying to calculate that with Section 41 r d tax credit as your starting point um just remember that section 41 expenses are very specific amounts that are that are going to be part of your 174 but not all everyone 74. one of those areas would be wage qures so when you kind of think about your wage QRS for your r d credit remember it's box one only but in the section 174 sense it's really the loaded employee costs so that would include gross wages their health insurance payroll taxes um basically how much does that employee cost to you that way because their employees and the activities associated with that employee and such Associated costs would be 174 incidental it would also include any forward wages or foreign third-party contractors to the extent that they are doing the work and again just a reminder foreign activities are not eligible for the r d tax credit but you would still have to capitalize and amortize that for Section 174 purposes over 15 years with the mid-year convention um lease of computers this is probably an area where I would expect the section 41 cost and the section 174 cost to be similar just make sure that you're carving out production costs associated with your Cloud hosting spend um or if this is truly leads to computers like you are renting laptops from Dell to perform your research and development carve out the portion of estimated time that the individual spends on the laptop for production work again that would likely follow the employees qualifying percentages for the r d tax credit um third-party contractors so we kind of talked about this instead of the 25 or 35 haircut that you would have to take for the r d tax credit the section 174 costs would require you to capture that at a hundred percent um a lot of people maybe sometimes forget to add those back so just make sure that you remember to do that um supplies that I would expect that area to be somewhat similar as well uh just to the extent that it meets technical uncertainty you are trying to address some of the challenges that you are seeing in your development process and you are consuming those supplies as part of that that would be section 174 and section 41 costs and Courtney did you want to cover the foreign activities um thanks I did want to go back and think about uh how we developed our methodology and looking at our clients um it is important to without the guidance that a 263 Cafe a forge or a d-pad type of a holistic approach I think it is important to understand what the IRS may be looking for or May issue his guidance going forward and we do have those two areas and other areas where you're allocating costs um and you know not necessarily directly but in times certain times indirectly for GNA accounts to see what the IRS has done in the past it gives you an idea of what they may do in the future so if you have experience working in them or if you're you know in an industry knowing your facts and circumstances with respect to the 263 Cafe d-pad there will be likely a similar analysis to be done here but again I saw a question earlier about foreign activity come through the um through the chat foreign this is an activity-based analysis so it's where the activity is conducted so when you're looking at vendors it will be where their employees are conducting the activity it's not necessarily the domicile of the entity that's doing the activity so if it's done in the U.S or U.S territories it's domestic offshore is offshore for foreign activity we look to mainly three areas or three categories of expenses it would be for employees that you might may be having offshore and this would include CFCs so if you have a CFC as you know you analyze the expenses as if they were a U.S taxpayer so this analysis will be not needed to be done if you have a CFC um so employees that are doing work that qualifies as 174 would need to be capitalized as well as any contractors that you're utilizing offshore doing their activities offshore would need to be capitalized as well as I think about this if you have people traveling that are U.S based but traveling overseas to do r d activity you would need to do an analysis to see what time they're spending on doing that activity offshore versus what they're doing here domestically include those together and then the third category will be any foreign supplies or any supplies that are being used in that foreign activity so that might be if you're developing a new manufacturing process say in China if you're running through raw materials in order to test that those types of supplies would be included as well foreign so depreciation and amortization that's different from the amortization if you're getting after you capitalize these expenses these will be depreciation and amortization expenses for assets that are being used in r d so let's say you have developed a piece of equipment that you're utilizing for testing it's capitalized you're utilizing it over several years to test your products the depreciation for that asset would go into the 174 analysis software will be included if you're doing software development you've got some developed software or some purchase software that you're advertising those costs would need to be included in the amortization or in the capitalization as well included in this is also an allocation of depreciation and amortization for assets that are utilizing the business overall these could be buildings it could be generally anything that's that applies to the entire organization that are incident to the r d and required so to the extent that you have a building you've got people working in the building they're doing the r d you would include that but there is an opportunity to exclude it if you have say a software development company that all of the people are working remotely they would not need to do if all the activity was done outside of the building the rent was specifically for administrative functions that don't necessarily test the r d in this case you wouldn't need to include that there may be expenses that the company is incurring to have those people work remotely but that's another consideration other incidental costs that you might want to include that we don't necessarily include insane r d credit but you need to look through your general ledger uh as you're doing this analysis might be for equipment rental that obviously is not uh being capitalized some shipping costs if you've got say a drug company that has you know doing testing on new drugs but they have to ship them out to the various clinical locations Etc that could be included as well um as well as any maintenance calibration Etc if you're developing a new product you need to test it a new manufacturing process you need to test that those costs need to be pulled in as well and again as as Vivian alluded to a reasonable allocation methodology as long as it again is reasonable as long as you're documenting it and it's traceable um will likely pass muster with the IRS but again just like everything else having to do with r d your substantiation your documentation Etc is key here so again it's not necessarily just your direct cost they're required to be um required to be capitalized again this gets back to the the to quote Marty the have any cost that's incident to the r d or connected with the r d needs to be included so there are costs overhead costs that need to be included in the allocation as well so General administrative costs things like rent things like office supplies technology communication keeping the internet running any licensing and permits that are required to keep the company running those need to be allocated um there are numerous ways you can do it again reasonable traceable documented Etc um you know you can do it based on again going back to that activity-based basis of the analysis if you can include the amount of costs for um the wages the people that are employed for overall over the um the amount of overall wages these are salaries um you can allocate it that way if that makes sense if it's more of a square footage consideration if that makes more sense for rent and you know what those costs those numbers are you can utilize that methodology but again it goes back to what information you have what makes the most sense what's reasonable what can be documented things that can be included and again this is these are things that you'll want to look at this is an expansive thing as Marty said but again we do want to look at the expenses that can be excluded things like sales marketing production related costs so you'll want to look at cost of goods sold you'll want to look at your sales Force Etc if they're not involved in the r d activities those costs don't need to be included and to the extent that you have cost-based accounting that makes that helpful again we are utilizing for the most part a general ledger approach so that we can identify things within trial balance accounts to identify advocate for our clients by pulling out some of these costs that might not be in a cost related trial balance account again really the key here is to be reasonable make sure that uh make sure that you can explain what you're doing and that is traceable back to the trial balance yeah so we're at our next poll and uh Maddie as you're bringing that up Vivian I did want to ask you um in talking about allocation you've actually worked worked through a couple of client situations recently on allocating expenses and working with them can you share a little bit about some of that experience helping them absolutely a good approach What It's always important to think about the facts and circumstances specific to the company because it's going to be different for everybody if one company it might make sense to not allocate any rent because none of their developers come into the office um other companies might make more sense to allocate by headcount um or if you have a big manufacturing company that has its r d space um in the same area as a huge warehouse space it would be important to maybe take a square footage approach as opposed to headcount approach just because warehouses generally take up a huge chunk of the actual rent and utilities so again it all really depends on what makes sense for your specific facts and circumstances um headcount approach is generally recommended because it is easier to figure out um for some of the GNA type support So if you're thinking about hey my CFO is supporting the entire company going back to that example that I was talking about maybe FTE number of ftes directly involved in r d would be a better approach because in in this example the CFO is supporting everybody equally versus if you wanted to allocate a fringe account maybe it makes more sense by allocating the 174 wages over total wages as opposed to headcount because presumably people are paid differently and your Fringe is based on your base pay so those are just kind of different areas and kind of different thinking and methodology that you can kind of approach things based on your facts and circumstances and so we had a question about using the um on the section 41 credit as a as a as an approximate or a way to use that in lieu of section 174 and I think as you guys have said um section 174 is really broader so uh and section 41 actually excludes costs like no foreign activities and uh only 65 percent of contract costs and things and and the kind of wage costs is limited that's included so you really need to to look further uh there was another comment about um hey if you're taking depreciation uh aren't we really just moving depreciation over somewhere else and recapitalizing and advertising it again um yes unfortunately that is what's being asked here for uh for for these purposes in section 174 uh there was one more question I wanted to address here um and Marty I think you're up next so you might want to uh talk about this before you talk software and that is um you know can you have is one call can one cost be a 162 ordinary necessary business expense in a section 174 uh uh a cost for research and experimentation expenditure at the same time not anymore all right back in the day yes you could you really didn't matter but it it it is it is a 174 expense only in this case it's capitalizable and amortizable and I know it's painful and the more homework we do we're finding more costs that have to be capitalized we had 700 people that signed up for this obviously we're not alone uh everybody's going through this together and uh we're doing our best to help companies come up with a reasonable methodology um based on the fact of circumstances in that year right uh it can change you're you're depending on what the company is doing I noticed somebody asked a question about whether or not coveted policies that were in effect that the company was adhering to uh that maybe kept people out of the office would that cause some amount of the allocation of the rent expense to go down possibly yes it really is based on what the facts and circumstances were in that year and 23 if those if more people are back in the office then yeah maybe maybe you have a higher amount of 23. great um Vivian you want to move us forward to uh to talk about software which is a pretty messy area it is definitely a messy area so as Marty alluded to earlier ref proc 2000-50 kind of gives you some guidance around what is software development so section 174 is very clear in stating hey software development is 174 just given the nature of what you do as a software developer um but it's important right that's how that's how your consultant or that's how we can come and help you is to figure out how best to carve out what is not software development so a lot of times what we kind of think about the capturing the wages for folks who are doing software development to the extent that they're doing any of the keep the lights on what they call ktlo um help desk tech support a lot of the is going to be maintenance repair some minor enhancements bug fixes that don't arise to the level of technical uncertainty that would not be software development some of the big questions I know someone asked this earlier on kind of Licensing and customizations of software so I would say that the straightforward installation implementation configuration of software is not software development however the customization pieces where you are where you are writing custom code on top of the license software or off the shelves product cots are what they call it um then that portion could potentially be 174. so it's always important to kind of think about how how much of my software development activities really is custom coding writing machine readable code that addresses technical that is technically uncertain versus straightforward implementation and installation uh kind of similar to software like on the same train of thought to the extent that as part of your software development or as part of your research and development of your products that's non-software to the extent that you guys are utilizing any of the software licenses or data subscription costs as part of your r d you would also have to include those costs as 174. um however some of those other licenses like for example Zoom or Microsoft Office so you can send out an email is probably more of a GNA type cost across that's used across all of the company so just remember you can maybe allocate those at a lower rate other software development costs that someone taxpayers should consider would be maybe potentially again this all depends on your facts and circumstances of your company so to the extent you're paying stipends for developers to work from home or maybe they have office meals weekly meals that's some of the fact patterns that we have seen as we discussed this more um as we go through GL approach is asking those questions like hey what are the costs associated with this GL account I don't I don't quite understand it is finding out oh yeah this is this is the weekly meal that's part of basically employee benefits so as such that's really um that's really part incidental to development and you can allocate it based on FTE um other types of software development costs would be to the extent you're using computer hardware um that not necessarily software but Hardware used for testing that would also need to be capitalized for r d 174 purposes all right oh yes Vivian thank you for assigning me the most controversial slide in the deck so um I appreciate it very much and the reason this is is because there's a fundamental unfairness that is inherent in some of these rules right now if we think about the research credit you have the concept of r d that is funded by an outside third party and by virtue of that the third party can claim a research credit for that and not the actual taxpayer who's doing the we'll call it development or potentially the software development in that case there is no um similar Concept in the 174 rules at least right now when it comes to um at least in the plain reading of the statute and the regulations this is clearly the area where we are craving guidance from the IRS because uh when you have an activity that qualifies as a research and experimentation and it is funded by a third party what happens in that case because from a research credit perspective you wouldn't have to you wouldn't be able to include it in your credit but the concept of funding is nowhere in the 174 regulations and so you end up with the possibility we'll think about something like double capitalization where the payor is paying for research performed by you and you're performing research and there's no carve out for that right now so what are what our best method is is to understand exactly what the nature of the activity is is there any amount it wouldn't be in the research credit anyway but is there any amount of the activity that can be reasonably uh said to be not a research and an experimentation expense but if it is there's no specific rule that allows you to uh not include it in your 174 across just because it's funded by someone else right now so clearly this is the area that's very gray as it says here no final guidance facts and circumstances look at your contracts look at what you're doing um and obviously consult with your Tax Advisor hopefully Us in that case because uh we have we have the benefit of seeing a multitude of um different fact patterns and just thinking about whether it's truly software development whether it's maintenance whether it's configuration maybe it's something else other than true development in that case um but clearly this is the area where we're all hoping hoping for some taxpayer favorable guidance in the future all right um just this is an easy slide to get through but again a little painful right from a domestic perspective as we mentioned there's a five-year you capitalize and amortize over five years but again it's a mid-year convention which means you only get 10 of the costs that are 174 that are currently deductible in the uh in the current year this foreign costs 15 years I mean you're really getting 1 30 of the 130th of it in 2022 uh when you think about applying this mid-year convention and this onerous rule here on disposition um you don't get to immediately deduct if you dispose retire or abandon the the project um during the amortization period it continues despite it being abandoned and so um that's very clearly stated in the rules um since this changed in 2022. so before we go into the next section there was a question about um uh some lease expense on data centers and yeah to the extent that those lease expense is for the portion of the data center that's used for software development or research and experimentation efforts yeah that's the kind of cost that would be incidental to and associated with a research and experimentation activities and therefore is the kind of expense that is falls under Section 174. um on on there uh again we had some questions about you know thinking about the funding research just hiring an engineer to do some work uh that work may not necessarily resolve uncertainty we we may know how to to already do something or to to design a website and so therefore it might not qualify as uh something that resolves uncertainty or qualifies as the software development so again uh you know looking at the kinds of activities that are going on uh and the kinds of things that are asked for is uh what's what's really important in this process good uh Manny how are we doing on the polling question there I just went ahead and ended that poll and the results are posted so most of you said about 15 years we have we have a spread between five and ten and a few said 39. right for new 2022 expenses under Section 174 is going to be 15 years uh if you were thinking about um something from a prior year you might have had that five or ten year um electable amortization in mind all right uh Court ing I think we're back to you on what goes into your 2022 tax return thanks Sarah I've kept an eye on some of the questions I think I can answer a number of them if I could just take a second to um emphasize something by repetition uh 174 is a requirement for taking the r d credit so if you take that logic backwards of anything that you're taking as an expense in your in your r d credit if you're taking if you're claiming an r d credit is required to be capitalized so salaries at least a computer supplies contract research both in the US and offshore but um anything that's onshore you're including in that r d calculation all those need to be capitalized just to take that a little step one step further the salaries that you're taking for the credit are W-2 salaries in this case for 174 we're required to utilize growth wages so it would include those pre-tax items benefits as well and then for the contract research expenses for the credit we're including those at 65 percent for most vendors we would need to gross that up to 100 for the capitalization um so this is an extension of the uh rev proc 2023-11 guidance and essentially what they're saying is that this isn't a method change but you're not required necessarily to file a 3115. it's a cut off method so it's all costs from the beginning of the tax year forward so anything after December 31st 2021 to the extent it's the first tax year you are able to file a statement and I'll go over what the requirements for that statement are in a second um but you're able to file a statement in lieu of filing that 3115. so everybody knows 3115 is kind of a daunting form uh this just what they've done is they've parsed out the relevant information that they would like to see without somebody that maybe doesn't have experience with 3115 having to go through that find out what the information they would need include versus what they could exclude one caveat is if it's a short if it's short tax year or the second year I guess if it's any second tax year uh in which you are first making that election you are required to file a 31-15 that includes a 41A adjustment for the catch-up expenses you would be required to deduct uh I'm sorry to capitalize so one thing to be careful about would be in the case where you have a short tax year that perhaps hasn't been filed yet it ended early in 22 or that's been extended um if you can file and it is extended you can utilize for that short tax year this statement in lieu but if extension wasn't filed the tax return is late that tax return would need to be filed as if 174 wasn't enacted because you can't elect on a late tax return and then the second tax year would be the second short year in which you would have to file a 31-15 so that goes against this third bullet point because I'm either misunderstanding that or no the the third bullet point just is if someone has already filed their 22 tax return it was uh say the short year was from January through uh June 30 and they filed already by uh say September 15 or October 15. um then they can include this statement in the first tax return following that so that would be the tax return say from July 1 to December 31 of 2022 they can put this statement in that return so any returns that were filed before this Revenue procedure was released in mid-January that is where they can attach the statement to their next tax return and don't have to go back and fix that 22 return that's already been filed the transition role yes so the return statement it's fairly straightforward in fact it's um it doesn't necessarily get too granular so what you need to include are taxpayer identification information what the tax year of change would be beginning and ending years uh the dcn the designated automatic change number is 265. we've done a 3115 automatic change you're familiar with that uh description of specific r d expenditures these will be the items that you're including whether direct or indirect fully including or allocating what they are so it would be things like rent things like salaries benefits Etc what we have been doing is tying that to trial balance accounts and including the methodology we're utilizing in allocating those expenses typically what you have you're going to have are your r d credit if you're taking an r d credit expenses you're going to have things that are directly allocated outside of that calculation and then you're going to have a bucket of allocated expenses whether they're ga GNA or otherwise and generally you're going to be allocating those based on one methodology there may be some outliers that you need to explain and otherwise but generally identifying the different accounts so that it can be tied you don't need to include the amounts that you're doing there just the items that you're doing in the description of them the next next item that you need to include is the total overall capitalized amount and then there's a statement that the above change is basically a description of the changes and if you look at the Rev proc they basically lay out exactly what needs to go in their word for word so that can be copyrighted into the into the statement okay all right this next slide is research credit specific what what this gets at is um historically speaking when you claim a research or credit by operation the code section called 280c the taxpayer has to reduce its deductions in that year by the amount of the credit um now going forward uh only to the extent the credit exceeds the amount of rme expense that is amortized in the year does 280c apply um it will be rare that the research credit is larger than the 174 amortization in the year it's possible in the first year because you're really only getting a 10 but it's it's only going to happen in like one of two cases one where you're claiming an alternative to simplified credit and the prior three-year uh qualified research expenses are extremely smaller than the amount in the current year so that you get a very large amount of the current year expenses that are credit eligible or if you get a short taxable year you know just a few months and as you go through the math somehow the uh the amount of RNE expense that's amortizable just over that short period ends up being a hair under what the what the research credit is um those are really the only two cases the good thing is um while you will have higher taxable income as a result of identifying 174 expenses that have to be capitalized and amortized the research credit is for most taxpayers going to be the full gross credit with no reduction um of deductions by the amount of credit because there's no deductions for the most part or a fewer anyway um so the credit will be the full gross credit for most taxpayers there will be no election to make the reduced credit under Section 2ac all right State and foreign tax considerations and I think this is getting close to our last slide so uh everybody I just want to put you I notice there's one more polling question after this but um you know for many states the beginning uh line item is what is your federal taxable income and with that in mind this is going to have an effect on your state filings to the extent that you're if you have a higher taxable income that will flow through the states now certain states accept the tax code as it existed say in 2013 prior year so this wouldn't necessarily apply uh in that particular case it's going to be state by state but it will have an effect on your state it can have an effect and many of your state filings additionally uh 174 changes are going to modify the taxable income uh number that provides discarding point for tax calculations such as fitty beat and the foreign tax credit so it's not just the research credit calculation it actually will be affecting some other areas of the tax law as well so we're in discussions with our International tax Brethren as well on this uh they're looking to ask for understanding 174 uh because it's going to flow through the fitty guilty and be calcium all right last slide last polling question I'll do it all right has your company started to identify as section 174 cost to capitalize yes we would like some assistance we're happy to give it unsure maybe at a later time or no we're all set again as we wait for the results here I just want to take a minute to thank everybody who put the time into this both those who did the slides and those who participated and attended today it's an hour out of your day I hope you got benefit out of it it's clearly important it's affecting taxpayers across the board um and you know we just want to be there for anybody that um needs Assistance or additional help thinking about this because while it has been in the law since 2017 and it was intended to come in in 2022 um many many every really tax provider thoughts this would be uh they would kick the can down the road on this one or that it will be retroactively taken out of the code um but it didn't and it wasn't and and it's here and so it's at least here to stay for 2022. do we hope something happens in the future we do and I wouldn't be surprised if it does if this rule changes at some point with maybe a catch-up provision on the on the untaken amortization but we don't know Marty there is actually a question around that in the Q a box um what are you seeing you know uh companies doing to kind of push or Congress to push this out try to repeal it maybe retroactively or not um I mean there's a number of Industry groups lobbyists working groups across the board no one wants this no one's Pro this idea no Republican no Democrat is pro this idea it was a pay for when it had when it came into the tax custom jobs act um and perhaps it was never intended to actually kick in but it did um and so um I think the pressure's on Congress it's really just a matter of finding the right timing and the right legislative vehicle to attach it to um they're well aware of the fact that this is unpopular uh by virtue of how many by virtue of how many people signed up today to listen to me I know it's unpopular so I I I I I think everyone's aware of this and uh Congress I would imagine we'll address this at some point great Vivian you want to go on to the last slide and Maddie I'll turn it back over to you to uh sort of close us out with what folks can expect next all right thank you guys so much uh you know Vivian Corning Marty Sarah we really appreciate all your insights and valuable information that you shared with us today you covered a lot of detail and really a short amount of time so if you do have any questions for this group today here's their contact info on the slide in front of you we value your feedback so we will be sharing a short survey at the conclusion and just a reminder we recorded this session we'll be sharing a copy of the recording along with the slides for you uh in about a week and uh with that if you guys have any other information feel free to jump in here but um thank you again so much for everything today that's it thank you all very much and we hope to hear from you soon foreign [Music]