Research and Development Tax Credit: Valuable Tax Savings Incentive Now Permanent
After many years as an expiring tax provision, the Federal Research & Development Tax Credit (R&D) has gained a permanent home in the U.S. tax code. The credit was first introduced over 30 years ago as a temporary incentive and has been included in extender legislation numerous times. The credit became permanent in December 2015 as part of the Protecting Americans from Tax Hikes (PATH) Act.
Now is a better time than ever for businesses with qualifying research expenditures to consider taking advantage of the R&D credit. In addition to making R&D a permanent tax incentive, the PATH Act made favorable changes that will result in more taxpayers being able to take advantage of the benefits of this credit provision.
- For tax years beginning after December 31, 2015, the R&D credit will be allowed to offset the Alternative Minimum Tax (AMT) liabilities of small businesses or their business owners. For this purpose, a small business is one with $50 million or less in gross receipts. Prior to 2016, the ability to offset AMT with the R&D Credit was not available. Previously, unused R&D credits for taxpayers subject to AMT were able to be carried back to the prior year or carried forward for up to 20 years. While the credit still maintains its carryback and carryforward provisions, the ability to currently offset AMT, within certain limitations, will be beneficial for many .
- The PATH Legislation also introduced an R&D incentive for “start up businesses,” which will be applicable for “qualified small businesses,” defined as those companies with less than $5 million in gross receipts and which are less than five years old. Businesses meeting this definition can elect to monetize the credit by taking advantage of a “payroll offset election.” For tax years beginning after December 31, 2015, the payroll offset will allow a qualified small business to elect to use a portion of the R&D credit now to offset payroll taxes, instead of waiting to use the credit to offset an income tax liability in the future. Qualified companies could have the option to apply up to $250,000 against the employer’s OASDI (social security) annually. The IRS recently published guidelines for the R&D payroll offset refund application process, utilizing payroll form 941.
In order to meet the definition of qualifying research expenditures, research activities performed in the United States will 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 include a process of experimentation involving identification of the technical uncertainties, alternatives to consider in eliminating the uncertainties and a process for evaluating alternatives.
The Research and Development Credit is calculated based on three types of expenses, when the expenses meet the definition of Qualifying Research Expenditures (QRE). Qualifying expenses eligible for the credit include wages, supplies used in the conduct of qualified research activities, and a percentage (65%) of third party contract research.
The determination of qualifying research activities is subjective in nature. The Internal Revenue Service and state jurisdictions that provide for the R&D credit opportunity require the credit to be supported by contemporaneous documentation. Taxpayers may be hesitant when considering the credit due to the necessary record-keeping. Tax professionals at Marcum are available to assist with identification and substantiation of QRES. Please contact your Marcum tax professional for further discussions regarding the Research and Development Tax Credit and new opportunities related to recent legislation.