Do you have a small business in search of tax relief?
The R&D credit – made bigger and better
Look out, Denver companies and especially small businesses: The IRS will soon issue new tax forms that will allow small business taxpayers to apply R&D credits to FICA taxes and AMT.
The R&D credit was first enacted as a temporary incentive in 1981 as a response to R&D incentives being offered by various European governments. Since then it has been extended 16 times, even suffering a one year lapse in the 1990’s. It is undoubtedly the most important tax incentive for many research-intensive sectors like technology, software, and IT, but its temporary nature has long undermined its effectiveness.
On Dec. 18, 2015, lawmakers passed PATH Act (“Protecting Americans from Tax Hikes ACT”) that enacted a number of tax changes, including making permanent 22 expired tax provisions. Among those made permanent was the Research and Development (“R&D”) tax credit. The credit is generated by aggregating expenditures incurred during the conduct of qualified research activities, as defined by the Internal Revenue Code. While the credit has been around since the 1980’s, most small businesses have not been able to benefit. The PATH Act changes that.
In addition to having been made permanent, the R&D credit was expanded to enable small business to monetize the credit benefit.
Although the R&D tax credit has been in place since the 1980’s, it has been a temporary credit making long-term planning uncertain. For the first time, taxpayers have received the gift of added certainty.
In addition to the permanent extension of the research credit, Congress added a new and expanded application of the credit in the PATH Act. Businesses that previously may have seen themselves unable to monetize the R&D credit, may now qualify and take advantage of the new provisions.
Qualified small business, may now offset not only regular tax, but may for any taxable year beginning December 31, 2015, elect to claim a certain amount of its R&D credit as a payroll tax credit against its employer FICA liability. This benefit is designed for start-up small businesses that have income tax losses. This is generally only available for the small business’s first five years, and only if gross receipts are no more than $5 million.
Furthermore, slightly larger businesses can now utilize the research credit to offset both regular and alternative minimum tax (“AMT”) tax liabilities, for taxable years beginning after December 31, 2015. Prior to the law change taxpayer could only use the credit to offset regular income tax. Taxpayers that meet the requirements of an eligible small business may now use the credit to offset AMT. This may benefit companies starting to turn a profit who have net operating losses from past years that push them into the AMT, which limits their ability to benefit from the R&D credit. To be eligible to offset AMT with your R&D credit, you must be a privately held businesses with no more than $50 million in annual gross receipts.
Recent guidance and case law has also made the credit even more valuable to taxpayers. The Tax Court recently rejected two common IRS arguments against R&D claims affecting Tech companies and startups. The court ruled in Suder v. Commissioner (T.C. Memo 2014-201) that certain executive employee wages can be allocated to research and that “routine” research that doesn’t “reinvent the wheel” can still qualify for the credit. These changes may be especially important to startups as executives are often directly involved in research.
Note: Nothing is simple, the definition of qualified small business and eligible small business are different. Contact your tax adviser for the criteria.
Because an employer generally files quarterly employment tax returns showing its liability for FICA taxes with respect to its employees’ wages for the quarter, as well as the employee FICA taxes and income taxes withheld, final forms are expected to issue before 2017. This should allow qualified businesses to file and claim the credit in the first quarter of 2017 to offset their FICA liability.
The IRS has issued draft forms. Final forms are expected soon. Now is the time to review and consider if you benefit from the new provisions. Taxpayers that previously may been unable to benefit from the R&D credit may be able to now.
Finally, the IRS requires the R&D credits to be documented. Small businesses need to be informed and diligent in generating and retaining required documentation.
Scott Remington is a Corporate Tax partner and Liza Zbarskaya is a Corporate Strategic Federal Tax Services senior manager at Grant Thornton LLP, a professional services firm with 60 offices around the country, including one in Denver. https://www.grantthornton.com/