May 10, 2016

Research & Development Tax Credit: Consider the Extension and Changes to Law When Preparing 2015 and 2016 Tax Returns

Contributor Diane Giordano, Partner, Tax & Business

Research & Development Tax Credit: Consider the Extension and Changes to Law When Preparing 2015 and 2016 Tax Returns

In December 2015, the Protecting Americans from Tax Hikes Act of 2015 (“Tax Extenders Bill”) was signed into Law. The law includes an expansion of the rules related to the Federal Research and Development (R&D) Credit effective as of January 2016, as well as making the R&D Credit permanent.

The purpose of this Flash is to provide details regarding the Research & Development Tax Credit (R&D) and remind taxpayers of the significant benefits that could be derived.

The R&D Credit is wide-ranging and is available to businesses in most industries, including but not limited to:

  • Manufacturing.
  • Software design.
  • Financial and professional services.
  • Technology.
  • Construction.

The R&D Credit is primarily a wage and consulting fee-based credit pertaining to employees and contractors who perform, directly support or directly supervise qualified research activities performed in the U.S.

The qualified research activities eligible for the credit must meet the following requirements:

  • Must be technological in nature.
  • Must be for a permitted purpose.
  • Technical uncertainty must be eliminated.
  • Must involve a process of working through the technical uncertainty.

Success of development is not necessary for the expenses to qualify; time incurred related to delays, redesigns and failures are all great examples of eligible R&D costs. Patents and applications are also excellent support for R&D.

In addition to the permanent extension, there are two significant pro-taxpayer changes to the application of the R&D Credit which will make it available to many taxpayers that have previously been discouraged from pursuing it or were not eligible to take advantage of its benefits.

The following new components of the R&D provision are effective beginning January 1, 2016:

  1. Credit Allowed Against Alternative Minimum Tax. The R&D Credit will now be allowed to offset the Alternative Minimum Tax (AMT) in the case of eligible small businesses or owners. An eligible small business under this provision is liberally defined as a private company with average annual gross receipts not exceeding $50 million for the prior three years. The R&D tax credit for pass-through entities, such as S Corporations, LLCs and Partnerships, which meet this threshold will be available to the members, partners or shareholders to reduce their personal income tax liabilities even if they are subject to AMT tax. Any unused credits can be carried back one year and forward 20 years.

    We want to remind our readers and clients that starting in 2016, even if you are subject to AMT, you should consider reviewing business operations for R&D Credit eligibility.
  2. Payroll Tax Credit Available for Start-Up Businesses. The new law now allows qualified small businesses to elect to utilize the R&D credit to reduce the FICA tax liability. A qualified small business is defined as a Corporation, Partnership, LLC or Sole Proprietorship which is less than five years old with less than $5 million in annual gross receipts in each of the preceding five years. The Payroll Tax Credit will be refundable up to $250,000 in payroll taxes per year. Any excess credit can be carried forward to future years. Previous use of the credit against an individual’s AMT was not permitted.

This new payroll tax credit provision will provide a significant windfall for qualified small businesses. Many small businesses do not pay significant income taxes during the start-up and growing phases. However, almost all small businesses have payroll tax liabilities which now may be reduced by claiming the credit.

Further, in addition to these new changes, the Credit was retroactively extended to January 2015 based on prior law. For those taxpayers who might believe the Credit does not exist for 2015 filings, now is an opportunity to contact your tax consultant to review 2015 expenses and planning for 2016.

Based on these changes and the new permanence of the credit, this is an optimum time for all businesses and their owners to reevaluate the potential benefit from the R&D tax credit. Marcum LLP has a team of tax professionals dedicated to R&D Credits and Incentives. Contact your Marcum Tax Advisor to arrange a review of your business to determine eligibility.