President Trump has signed into law the Consolidated Appropriations Act (CAA), a bill that includes over $900 billion in relief intended to help businesses and individuals affected by the economic consequences of the COVID-19 pandemic. One key provision in this new law has significant good news for businesses that took out Paycheck Protection Program (PPP) loans, including those who claim the research and development (R&D) tax credit. Another provision provides some important caveats for businesses that plan to claim the employee retention credit (ERC) in addition to an R&D tax credit.
The original IRS position on deductibility
Businesses that took out PPP loans can qualify for automatic forgiveness of the debt if they meet certain requirements. The IRS pointed out last spring that expenses paid with PPP loans that were later forgiven would not be considered deductible for income tax purposes. This caused confusion among employers as to whether or not the costs of payroll funded by PPP expenses would be deductible at year-end. It also added an extra level of complexity for businesses that include payroll attributable to R&D activities in the calculation of their R&D tax credits. The IRS stated at the time that Congressional action would be required to make these expenses deductible.
Congress clarifies deductibility of PPP-funded expenses
The CAA delivered that Congressional action. The new law includes a clarification of the treatment of business expenses by businesses that received PPP loans that were subsequently forgiven. It expressly provides that the intent of the original legislation was to permit such expenses to qualify for a deduction. This paves the way for businesses to deduct the payroll taxes and other related expenses that were paid using PPP proceeds, and it also frees up the use of those expenses for use in calculating the payroll-based components of R&D expenses in that valuable tax credit. In short, the CAA has effectively returned us to a “business-as-usual” footing for calculating R&D tax credits after several months of uncertainty about the use of payroll expenses in the computation of credits at businesses who took out PPP loans.
R&D tax credits and the employee retention credit
The news on the ERC front isn’t quite as good for employers who also claim R&D tax credits, but any concerns should be manageable with some modifications to the tracking of wages allocated to R&D. The two key things to remember about how this COVID-19 relief bill affects the R&D tax credit calculation are:
- In 2020, at businesses that employed more than 500 individuals, the ERC could only be earned on wages paid to employees who were not performing services. Since they were not performing any services, they could not be engaged in “qualified research activities.” If your R&D expense tracking system treats the hours of some research personnel as “qualified research activities” by default, you’ll need to review their time to make sure that wages paid during a period when they were not performing services are backed out of the R&D tax credit calculation.
- In 2021, the revised rules of the ERC specifically exclude any wages used to determine the ERC from being treated as qualified for R&D tax credit purposes. Employers claiming both credits will need to make sure that there is no overlap between wages used to calculate the ERC and wages used to calculate the R&D tax credit.
Year-end planning with R&D tax credits
If your business has relied on R&D tax credits in the past, the new law should give some peace of mind that any PPP relief claimed during the year shouldn’t affect the process of calculating the credit this year. If you plan to claim both the employee retention credit and the R&D tax credit in 2020 and/or 2021, the level of detail required in your documentation for wages attributable to qualified research activities may have just gotten a little bit more complicated.
As always, the calculation of the R&D tax credit remains highly dependent on the facts and circumstances of each taxpayer. If you have any questions about the calculation of this year’s credit or your business’s potential eligibility for this valuable tax incentive, please contact your Plante Moran advisor.
