Cloud computing costs in Iowa are excluded in calculations for R&D credits, but treatment of leased computing varies by state. Cloud computing costs are also an audit issue so, shore up documentation.
The inclusion of cloud costs in the calculation of research and development (R&D) credits varies by state. Iowa’s latest changes on leased computer costs, effective January 1, 2023, serve as an example of how cloud expenses can impact R&D calculations.
Iowa’s new law eliminates expenses for the use of third-party computers in the conduct of qualified research under Internal Revenue Code section 41(b)(2)(A)(iii) from being considered as Iowa qualified research expenses.
Iowa employs a distinct approach to the research credit computation. While most states include only expenses incurred within their borders for the current year and the base, Iowa starts with federal qualified research expenditures (QREs) and credit. It then determines the portion that qualifies as Iowa QREs and calculates the credit accordingly. The recent change requires taxpayers to reduce their federal QREs by their leased computer costs, recompute their federal credit without these costs, and then allocation the revised credit to Iowa.
Why the Change
Iowa faced issues around 2019 when it made its R&D credit refundable. This coincided with Google opening a massive server farm in Council Bluffs and many companies shifting development, prototyping and testing platforms to the cloud.
This led to a surge in credit refunds, even for companies with losses. In response, Iowa began auditing aggressively and disallowing cloud costs. To address this, Iowa retained the refundable credit but excluded leased computer costs for the tax year 2023 to curb the flood of cash claims.
Shoring up Documentation
The IRS is also making cloud computing costs an audit issue, making it prudent for taxpayers to shore up their leased computer costs documentation for both federal and state purposes. If you are including these costs in your credit, you can better validate your leased computer costs documentation by collecting:
- Location of the leased computer services
- Hosting type, whether hosted or shared
- Itemized list and description of services
- Date or duration of the service
- Pricing breakdowns, such as hourly or flat rates
- Business component or product related to the service
For more guidance on handling leased computer costs in Iowa and elsewhere, reach out to your TaxOps advisor.
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