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R&D Tax Credit to Offset AMT and Payroll Tax
It will be welcome news to many in the business community that the research and development (R&D) tax credit has been permanently extended by Congress, retroactively as of January 1, 2015. The R&D credit extension, part of the Protecting Americans from Tax Hikes (PATH) Act of 2015, was signed into law by the President on December 18. In addition to credit permanency, the legislation makes several important enhancements to expand how R&D credit benefits can be currently utilized by certain small businesses.
Impact on Small to Mid-Sized Businesses
The legislation also broadens the impact of the credit for many small to mid-sized businesses. Under prior law, the R&D tax credit could only be used to offset regular tax; this rule limited many small to mid-sized businesses in their ability to use the credit if they were subject to the alternative minimum tax (AMT). This is especially true for many owners of pass-through entities. However, starting January 1, 2016, "Eligible Small Businesses" will be able to use the R&D tax credit to offset AMT. An Eligible Small Business is defined as a business with less than $50 million in average gross receipts for the three preceding years.
In addition, "Qualified Small Businesses," defined as a business with less than $5 million in annual gross receipts and having gross receipts for no more than five years, will now be able to use the R&D tax credit to offset the FICA employer portion of payroll tax. The amount of credit that can be used to offset payroll tax is capped at $250,000 for each eligible year.
The enhanced ability for small businesses to currently use the credit should result in more immediate cash benefits for many companies, particularly start-ups, because they will not have to wait until they generate taxable income to take advantage of the credit savings.
R&D Tax Credit
The R&D tax credit was first enacted as a temporary credit in 1981. Since its original enactment, the credit has remained temporary and has expired 16 times, with only a one-year lapse in the credit from 1995 to 1996. In recent years, the credit has been allowed to expire, but has been routinely extended retroactively as part of tax extenders legislation. The credit last expired on December 31, 2014, and was not in effect for 2015 until it was retroactively and permanently reinstated by the PATH Act.
Like many other tax extenders provisions, the intent of the R&D tax credit is to encourage and incentivize businesses to undertake certain behavior (in this case, to invest in R&D activities). This incentive effect had been dampened by the uncertainty companies have faced because of the temporary nature of the credit.
At long last, the R&D credit is now a permanent provision of tax law. This certainty is a big win for businesses investing in research and development, particularly smaller businesses, as they now have an increased ability for using the credits generated.
R&D Tax Credit Administration
While the permanency of the credit and enhancements made by the PATH Act will surely be lauded by the business community, one key provision that had appeared in earlier proposals did not make its way to the final bill-the structure of how the credit is calculated remains unchanged. This means that the "Regular Credit," which can rely on comparing current year expenses to a base amount that often requires data from the 1984 - 1988 period remains in place.
An "Alternative Simplified Credit" (ASC) is available and only relies on the prior three years' data to compute a base amount; however, the ASC results in a lower effective credit rate for many companies. Previous proposed versions of the tax extenders legislation had proposed to raise the ASC to a 20 percent credit and phase out the Regular Credit. This change would have made administering the credit much easier but was not included in the extension.
A final reminder, the permanent extension of the R&D tax credit is effective as of January 1, 2015; however, the enhancements that allow the credit to offset AMT and payroll tax do not go into effect until January 1, 2016.
Impact on Small to Mid-Sized Businesses
The legislation also broadens the impact of the credit for many small to mid-sized businesses. Under prior law, the R&D tax credit could only be used to offset regular tax; this rule limited many small to mid-sized businesses in their ability to use the credit if they were subject to the alternative minimum tax (AMT). This is especially true for many owners of pass-through entities. However, starting January 1, 2016, "Eligible Small Businesses" will be able to use the R&D tax credit to offset AMT. An Eligible Small Business is defined as a business with less than $50 million in average gross receipts for the three preceding years.
In addition, "Qualified Small Businesses," defined as a business with less than $5 million in annual gross receipts and having gross receipts for no more than five years, will now be able to use the R&D tax credit to offset the FICA employer portion of payroll tax. The amount of credit that can be used to offset payroll tax is capped at $250,000 for each eligible year.
The enhanced ability for small businesses to currently use the credit should result in more immediate cash benefits for many companies, particularly start-ups, because they will not have to wait until they generate taxable income to take advantage of the credit savings.
R&D Tax Credit
The R&D tax credit was first enacted as a temporary credit in 1981. Since its original enactment, the credit has remained temporary and has expired 16 times, with only a one-year lapse in the credit from 1995 to 1996. In recent years, the credit has been allowed to expire, but has been routinely extended retroactively as part of tax extenders legislation. The credit last expired on December 31, 2014, and was not in effect for 2015 until it was retroactively and permanently reinstated by the PATH Act.
Like many other tax extenders provisions, the intent of the R&D tax credit is to encourage and incentivize businesses to undertake certain behavior (in this case, to invest in R&D activities). This incentive effect had been dampened by the uncertainty companies have faced because of the temporary nature of the credit.
At long last, the R&D credit is now a permanent provision of tax law. This certainty is a big win for businesses investing in research and development, particularly smaller businesses, as they now have an increased ability for using the credits generated.
R&D Tax Credit Administration
While the permanency of the credit and enhancements made by the PATH Act will surely be lauded by the business community, one key provision that had appeared in earlier proposals did not make its way to the final bill-the structure of how the credit is calculated remains unchanged. This means that the "Regular Credit," which can rely on comparing current year expenses to a base amount that often requires data from the 1984 - 1988 period remains in place.
An "Alternative Simplified Credit" (ASC) is available and only relies on the prior three years' data to compute a base amount; however, the ASC results in a lower effective credit rate for many companies. Previous proposed versions of the tax extenders legislation had proposed to raise the ASC to a 20 percent credit and phase out the Regular Credit. This change would have made administering the credit much easier but was not included in the extension.
A final reminder, the permanent extension of the R&D tax credit is effective as of January 1, 2015; however, the enhancements that allow the credit to offset AMT and payroll tax do not go into effect until January 1, 2016.
