Newly-Permanent Research Tax Credit Opens Opportunities for Businesses of All Sizes
2015 was a great year for the federal Research Tax Credit (RTC): in January 2015, proposed regulations significantly broadened the range of software-development expenditures eligible for the RTC; and in December 2015 the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) permanently extended it.
By putting an end to the credit’s 34-year roller-coaster history of expiring and being extended (often only retroactively), the PATH Act enables businesses to factor the RTC into their regular tax planning and investment decisions. In addition, the PATH Act creates new opportunities for taxpayers in virtually every industry to benefit from the credit now, instead of only (possibly) in the future.
New Opportunities for Small Businesses
Although the PATH Act doesn’t include the numerous proposals to change how the RTC is calculated or increase its credit rate, it does expand its availability to two kinds of small businesses.
First, “eligible small businesses” may now claim the credit against their Alternative Minimum Tax (AMT). Under prior law, companies generally were able to use the credit to offset only regular income tax liability. This meant small companies and pass-through entities subject to AMT often couldn’t benefit currently from the RTC. Although this provision applies to tax years beginning after December 31, 2015, such companies may be able to use their 2016 credit against their 2015 tax liability if they can carry it back one year, as Internal Revenue Code (IRC) section 39 allows for other General Business Credits.
Second, “qualified small businesses” may now elect to take up to $250,000 in RTCs against the employer portion of their payroll or FICA taxes. This election, which can be made for up to five taxable years, provides start-ups a significant and immediate benefit, enabling them to recoup some of their investment to develop new or improved technologies, even if they aren’t currently paying regular income taxes.
“Eligible” and “Qualified” Small Businesses
“Eligible” small businesses are different from “qualified” small businesses.
Eligible small businesses include closely held corporations, partnerships, and sole proprietorships whose annual gross receipts for the three preceding tax years average no more than $50 million.
Qualified small businesses are corporations, partnerships, or persons (1) not exempt from income tax under IRC section 501; (2) with gross receipts in the taxable year of less than $5 million; and (3) with no gross receipts prior to the five taxable years ending in the taxable year. For purposes of this provision, all members of the same controlled group or group under common control are treated as a single taxpayer, and the $250,000 amount must be allocated among the members in proportion to each member’s expenses on which the research credit is based. Read more on CPA Practice Advisor.