Technology R&D Tax Credits: Tax Changes, Documentation and Compliance Strategies

HOST (DAN WEEDEN): Welcome to the Technology Podcast series brought to you by Cherry Bekaert, where we explore the industry's complex landscape and discuss the challenges and opportunities facing today's technology companies. Join us as we uncover strategies that drive growth, innovation, and scalability in this rapidly changing sector.

HOST (DAN WEEDEN): Welcome back to Cherry Bekaert's Technology Podcast. I'm Dan Weeden. In this episode, we're continuing our discussion with Vivian Korrs, a Partner in our Research & Development Tax Credit Group. We'll be focusing on the latest tax law changes, Section 174 considerations, and what technology companies should be doing now to maximize and support their R&D tax credit claims.

HOST (DAN WEEDEN): Vivian, has any of this changed with the One Big Beautiful Bill?

VIVIAN KORRS: Absolutely. I think that was the biggest thing that came out of it. It was a life-changing tax bill for sure.

As taxpayers who had to capitalize and amortize their development spending, that was the biggest change. When it comes to R&D credits, we've really been talking about R&D tax credits under Section 41. The One Big Beautiful Bill didn't necessarily change the R&D tax credit itself.

What it did change is what I would call the R&D tax credit's evil twin sister, which is Section 174. Section 174 covers research and experimentation costs. Under the Tax Cuts and Jobs Act (TCJA), companies had to capitalize and amortize onshore research and experimentation costs over five years and offshore research and experimentation costs over fifteen years.

To put it simply, if you spent $1 million on development, you didn't get to write off that $1 million immediately. Instead, you could end up with an unexpected tax bill that artificially inflated your taxable income compared to your book income.

The One Big Beautiful Bill fixed the onshore portion. Federally, taxpayers can now return to immediately expensing onshore research and experimentation costs for tax years beginning after December 31, 2024.

Offshore costs are different. The government is incentivizing onshoring, so offshore research and experimentation costs still need to be capitalized and amortized over fifteen years under the One Big Beautiful Bill.

That's an important consideration. At least federally, they fixed the treatment for onshore development costs.

There is also a relationship between Section 174 and the R&D credit. The government doesn't want taxpayers to double dip. They don't want you to receive both an expense deduction and a credit for the same dollar.

There is a Section 280C election that essentially says that, to make life easier, you don't adjust your taxable income. Instead, you take a reduced credit equal to 79% of the gross credit.

That election becomes relevant again because taxpayers can now expense their research and experimentation costs for onshore activities. As a result, instead of reporting the full gross credit, most taxpayers will see a 21% reduction so they don't have to add the gross credit back into taxable income.

So while you can now expense your onshore development costs, you do experience a reduction in the credit compared to taking the full gross credit.

HOST (DAN WEEDEN): Great. How are states responding to Section 174A, and where are you seeing conformity or nonconformity at the state level?

VIVIAN KORRS: This is an ever-changing landscape. As recently as last week, I believe three states potentially decoupled. We're continuing to monitor developments and provide updates as they emerge.

We actually have a map that our marketing team helped create that shows which states conform or do not conform to federal treatment of Section 174A costs, which are domestic research and experimentation costs.

Because states are required to maintain balanced budgets, more and more states are decoupling from the One Big Beautiful Bill's treatment of Section 174A costs.

What this means is that federally you can expense your domestic costs, but depending on which states you file in, and more often than not, those states may not conform to the federal treatment. For state tax purposes, you may still need to capitalize and amortize those costs and maintain separate tracking.

HOST (DAN WEEDEN): Excellent. What about companies that already capitalized R&D costs from 2022 through 2024 under the prior rules?

VIVIAN KORRS: That's where there is still time to think about tax planning.

For most calendar-year taxpayers, you currently have a choice. If you're not an eligible small business and didn't make the required statements on your 2024 return indicating an intent to amend, then in 2025 you can evaluate your unamortized balance of previously capitalized domestic research and experimentation costs.

You can decide whether to write off the remaining balance entirely in 2025 or spread it over two tax years.

The reason to evaluate that choice is because you could potentially create a net operating loss position and be unable to fully utilize all of your tax attributes if you take the entire deduction in 2025 without sufficient income.

It's important to project the outcomes and determine whether taking the deduction in one year or over two years makes the most sense.

HOST (DAN WEEDEN): What about post-2025 planning and the impact on technology companies? What are some considerations?

VIVIAN KORRS: With AI becoming more prominent in everyday life and across technology companies, it's important to look closely at those costs.

Many cloud platforms allow you to pull detailed reports, but often only for the previous twelve months. After that, detailed reporting may no longer be available.

It's important to pull and preserve that information now so you can determine how much of those costs relate to development environments, testing environments, and staging environments, as opposed to production environments or general administrative storage environments.

Having that support allows you to substantiate and bifurcate those costs appropriately. You'll be able to explain how much of your cloud spending qualified for the credit and provide documentation supporting that position.

Another consideration involves major implementations or software development lifecycle migrations. When setting up project tracking and coding structures, having the right documentation readily available can optimize the credit claim process.

Any time you're undertaking a new initiative, planning a major release, or revamping an entire technology stack, that's the time to start planning for the R&D credit.

Maintain supporting documentation, including architectural diagrams, meeting minutes, and records of design discussions. Whether you're evaluating a two-layer architecture versus a three-layer architecture or considering other design alternatives, document those decisions and preserve them.

That information helps significantly. The IRS continues to request more contemporaneous documentation. When evaluating R&D tax credit claims, the IRS wants to see proof that activities satisfy the four-part test.

Having documentation available strengthens the claim and helps substantiate the credit.

HOST (DAN WEEDEN): Excellent. What about compliance? What's changed on the form side?

VIVIAN KORRS: That's another major development.

Form 6765, which is used to claim the federal R&D credit, remained relatively unchanged for many years. The significant changes began with the 2024 tax year.

The IRS is asking for increasingly detailed information so it can perform data analytics and identify potentially risky claims.

Beginning with the 2026 tax year, there will be additional requirements to break out development spending by business component. A business component is essentially IRS terminology for a project.

It's important to track costs at the project level. The IRS is also requiring taxpayers to further categorize wage expenses into direct development, direct supervision, and direct support.

Companies need to track activities carefully. The goal is to establish a clear nexus between qualifying research activities and qualifying research expenses. That is what the IRS is looking for.

Previously, none of this information was reported on the form. Taxpayers generally reported qualifying research expenses for wages, supplies, and contract research, and that was sufficient.

That is no longer the case. The IRS is requesting significantly more detail at the time returns are filed.

Taxpayers must identify the types of business components being developed, whether software, processes, formulas, or other projects, and provide a breakdown of qualifying research expenses by project.

This reporting requirement becomes mandatory for the 2026 tax year if qualifying research expenses exceed $1.5 million.

There is some relief for smaller taxpayers. However, if your organization is spending more than $1.5 million on development, it's important to establish these tracking processes now so you're prepared when the reporting requirement takes effect in 2026.

HOST (DAN WEEDEN): Excellent. Thank you, Vivian. That brings us to the end of our conversation today.

I really appreciate the insights. We covered a great deal of information, and I've certainly come away with many new ideas regarding R&D tax credits, recent legislative changes, and the various considerations our clients should evaluate while operating in a technology environment.

Thank you for sharing your expertise and helping make a complex topic more understandable.

VIVIAN KORRS: Thank you so much, Dan, for having me here. I really enjoyed the discussion.

HOST (DAN WEEDEN): Hopefully this gives everyone a clearer picture of how R&D tax credits may apply within your organization and how to approach them strategically.

Thank you for listening today, and we look forward to having more conversations with all of you in the future.

HOST (DAN WEEDEN): Thank you for listening to our podcast today. For more information, visit our website at cbh.com/technology.

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