How the Coronavirus and PPP Impact the R&D Tax Credit

Many aspects of business changed over the last three months. Between shelter in place orders, a slowing economy, and regulatory changes under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), we will feel the effects for months. At first glance, certain areas of tax law, such as the R&D Tax Credit, do not change considerably with these regulations. However, as more information regarding the implementation of the Paycheck Protection Program (PPP) comes out, it becomes clear that the R&D Tax Credit could be affected.

By now, most businesses and CPAs have a good understanding of how loan forgiveness under the PPP works. For participating businesses, up to eight weeks of payroll, as defined in the program, will be forgiven. Traditionally, loan forgiveness creates a taxable event; however, under the CARES Act, PPP proceeds are specifically excluded from taxable income. Under Notice 2020-32, the IRS interprets this to mean the business does not own deductions paid with forgiven funds. The notice states: “Specifically, this notice clarifies that no deduction is allowed… for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a covered loan… and the income associated with the forgiveness is excluded from gross income…” While ranking members of Congress stated this does not follow the intent of the law, Secretary Steven Mnuchin stands by this interpretation.

If the law does not change, how will the calculation of R&D Tax Credits impact the 2020 tax year? Under Section 41, “Qualified Research Expenses” are amounts “paid or incurred” during the tax year. If the IRS’ interpretation of the PPP holds true, the taxpayer will not be eligible to include amounts forgiven under the PPP in qualified expenses, and the result is a reduced R&D Tax Credit for the year.

Should Congress fix the law to ensure their R&D Tax Credit intent is followed by those affected by COVID-19? COVID-19 is disrupting day to day operations for many businesses in 2020. An engineer who traditionally works on R&D eligible “process improvements” may be working from home, unable to complete traditional functions. However, in another business, an engineer may be asked to revamp a manufacturing process to manufacture PPE, such as masks or ventilators. This means a business may see the amount of time a professional works on research-related activities fluctuate drastically in the 2020 tax year.

On top of all changes, the necessity of cash flow in the current economic environment is higher than ever. This makes the R&D Tax Credit critical. With the intricacies of the new tax law, combined with the change in the work environment, it is important for businesses to utilize experienced professionals in ensuring their R&D claims are maximized and sustainable. McGuire Sponsel employees are versed in the R&D Tax Credit as well as COVID-19 legislation. As pandemic-related regulations continue to change, McGuire Sponsel is dedicated to providing trusted advice and proven solutions in these critical areas.