There are different tax treatments for research and experimentation expenses, but the taxpayer needs to bear in mind that R&D credit has a one-year carry-back, but a 20 year carry -forward rule for unused R&D credit amounts. The taxpayer has an option of deducting all R&D costs as an expense in a single year, a write-off over an optional 10 years, or amortizeing the R&D costs after the first benefit's received. The first option is to deduct R&D costs in the tax year, which expenses incurred or paid.7 The caveat in deducting R&D expenditures in a single year is, the R&D expenditures are limited to the R&D credit amount and the direct write-off method will cause losing great amount of deductible expenses in tax liability. The second option is to capitalize R&D expenses when the R&D expenditures extentd the deductible amount for the taxable year.8 After capitalizing R&D expenses in tax purpose balance sheet, you can write-off in a 10 year period with the taxable year in which expenses wasere paid or incurred. The last option is deferred R&D expenses can amortize for 60 months or more after the first economic benefit was received. However, being eligible to amortize the R&D costs involves two requirements, which are: all paid or incurred R&D expenditures must be related to trade or business and should not currently be deducted as an expenses, and the amortization period starts with the first date of benefit received.
Since all R& D projects were acquired through mergers, the company can include only a proportionate share of qualified research expenses in the computation of R&D credit for the year of acquisition took effect. For the years after the acquisition, Wahoo Software Inc. would include the full prior year’s qualified research and qualified expenditures amounts in the computations of R&D credit.
Even though, there are court cases such as U.S. v. McFerrin (5th Cir. 2009) and Union Carbide Corp. v. Commissioner (TC Memo 2009-50), which were applied Cohan Rule, decided that the taxpayer might estimate research and experimentation expenses in the absence of certain documentation, still the taxpayer must prepare and retain specific documentation. Those required documents includes W-2’s, payroll register, work schedules, or other tracking documents that are associated with the labor costs, invoices for the supplies, payment receipts that made third party for conducting qualified research activities, and any other documentation that tracks progress of R&D performed.
Decision
Based on I.R.C. §41(b), R&D credit apply as long as a company meets certain requirements. Furthermore, R&D credit might be beneficial for Wahoo Software, Inc. by having dollar-by-dollar reduction in federal income tax liability. After the comparison of possible tax accounting treatments for the company, writing-off R&D expenditures as a current business expenses, capitalizing and then amortizing R&D expenditures after the technology absolutely does not create a favorable outcome for the company. Based on the related rules and the company’s underlined fact, which is carrying forward net operating loss, writing-off R&D expenditures over a 10 years period would be a more favorable tax accounting treatment for the company. While the company will be able to write-off R&D expense amount by amortization, at the same time the company will create and increase R&D credit amount over the years. Since, NOL and R&D credit are not allowed to be used atin the same tax year, after offsetting all net operating losses, carryiedng forward unused R&D credits will take effect and reduce dollar -by -dollar income tax liability for the company.