Research and Development (R&D) Tax Credit Applicability and Benefit
The R&D Tax Credit, Now Permanent, Offers More Benefits To Taxpayers Under The Tcja Along With Changes To The Alternative Minimum Tax.
The federal Research and Development (R&D) Tax Credit provides significant benefits to taxpayers with qualifying expenses. Recent changes in law in the Tax Cuts and Jobs Act (TCJA) and the 2015 Protecting Americans from Tax Hikes (PATH) Act have made the R&D credit even more lucrative, by providing taxpayers potentially larger credits for tax years ending after December 31, 2017. Changes in both of these laws make the R&D credit a very powerful tool to reduce a taxpayer’s tax liability and increase cash flow.
The R&D credit is a federal program and is available to businesses in most industries, including, but not limited to:
- Architecture & Engineering
- Software & Technology
- Financial and Professional Services
- Environmental & Life Sciences
TCJA Impact on
R&D Tax Credit Opportunity
The TCJA did not directly change the qualification requirements. However, the TCJA effectively increases all post-2017 R&D benefits by 21%, due to a Section 280C adjustment increase from 65% to 79%.
Path Act Changes
Changes to the PATH Act made the R&D Tax Credit permanent for tax years beginning after December 31, 2015.
The Act also allows the R&D credit to be applied against the employer portion of OASDI (Social Security) of the payroll taxes for “qualified small businesses.” A qualified small business is defined as follows:
- A company with gross receipts of less than $5 million for the present tax year.
- A company that did not exist or have gross receipts in any tax year prior to the 5-tax-year period ending with the current tax year.
- A company that has qualifying research activities and expenditures.
- A company that has payroll tax liabilities.
The payroll credit is limited to $250,000 per year for up to five years, and any unused portion can be carried forward to future years.
The tax credit may also be claimed if the business uses a certified Professional Employer Organization (PEO). This provision allows qualified small businesses the ability to utilize the R&D credit against payroll taxes, where previously they might not have had the opportunity to utilize the credit due to the absence of taxable income.
Alternative Minimum Tax Relief
Another benefit added as part of the PATH Act was the ability to utilize the R&D credit to offset Alternative Minimum Tax (AMT) for taxpayers with $50 million or less in average annual gross receipts, based on the three preceding tax years.
Tax Credit Guidelines
The R&D credit is calculated by determining the amount of Qualified Research Expenditures (QREs) for the company’s current and prior tax years. The QREs are made up of wages, supplies used in R&D development, and 65% of fees from third party contractors.
In order to meet the definition of qualified research expenditures, research activities performed in the United States need to satisfy a “Four-Part Test”:
- The work is being performed to develop a new or improved business component (product, process, technique, formula, invention, or computer software component).
- The activities are performed to discover information that is technological in nature. The activities involve physical, biological, engineering, or computer sciences.
- The research is performed to eliminate technical uncertainty, determine if a desired result could be achieved, how to achieve it, or determine the specific design of a product.
- The activities includeparocess of experimentation involving identification of the technical uncertainties, alternatives to consider in eliminating the uncertainties, and a process for evaluating alternatives.
The TCJA and PATH Act have significantly increased the value of the R&D Tax Credit and the opportunity to consider its impact in year-end tax planning. In addition to the federal credit, many states have their own Research & Development credits, making this potential tax strategy even more beneficial. Effectively using the R&D credit will help increase a company’s cash flow by reducing taxes and the amount of quarterly estimates due. Companies may also be eligible to claim the credit for prior years.
Contact your Marcum professional to determine whether your company may qualify.