Country / Language

R&D Tax Credit Made Permanent, Enhanced for Small Businesses


3/2/16

Synopsis
 
On December 18, 2015, Congress passed an extenders package called the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act). The new law makes the research and development (R&D) tax credit permanent, retroactively to January 1, 2015, and preserves both the regular credit and the alternative simplified credit. This allows taxpayers to compare which method is best. In addition, the law makes two key enhancements for using the credit targeted to small businesses.
 
Background
 
The R&D tax credit was enacted as a temporary provision back in 1981 to provide an incentive for companies to invest in innovation in the United States. Available for any industry, companies that develop new or improved products or processes can qualify.
 
Essentially, the R&D tax credit is an activity based jobs credit. Companies with employees developing new products or processes in the United States can be eligible for this credit. For example, companies that have improved their products (new functionality, higher quality, better performance), created new products (or software), or automated the manufacturing lines may be eligible to take this credit. Eligible costs include wages of those employees, supplies, and costs related to contract research. Many states offer significant R&D tax credits in their own right, giving companies a federal and state(s) credit in the same year. Unused credits can be carried back on the federal return one year or carried forward 20 years.

Limitations of the R&D Tax Credit
 
While this tax credit has been useful to some companies, its lack of permanency over the years, and unclear rules, have made claiming the credit uncertain. Because the credit was temporary, taxpayers had to rely on Congress to extend it each year. Congress would often have to reinstate the credit after it had already expired. After 16 extensions, many had argued the R&D tax credit had lost its effect.
 
In 2007, companies had another way to compute their credit. Known as the alternative simplified credit (ASC), this method provides a way for companies to still take the credit if they didn’t have sufficient documentation to support the credit under the regular method. The ASC method only requires companies to look back three years rather than decades. Companies tend to have records from three years ago so this was also helpful for companies with historically high R&D costs to once again use the credit.

Another challenge in using the credit is that it was only useful to those companies that actually had regular tax. Historically, the R&D credit cannot be used against the alternative minimum tax (AMT). Therefore, the credit was of little value if it couldn’t be used. With the PATH Act, small businesses finally have some relief in utilizing the credit.
 
Enhancements for Small Businesses
 
Small businesses that couldn’t use the credit in the past can now use the credit against AMT and the employer portion of payroll tax.
 
Credits can be used against AMT
 
Many small businesses that have passed on the R&D tax credit because they couldn’t use the credit can now use it against the AMT starting in 2016. Eligible small businesses are non-publically traded companies with less than $50 million in sales averaged over the prior three years. The PATH Act removes a longstanding road block that prevented small businesses from using the R&D tax credit. Small businesses, especially pass-through entities, should reconsider this credit in 2016.
 
Credits can be used to offset employer payroll tax

Many small businesses still in start-up mode don’t have any tax liability so filing for the R&D tax credit did not make sense. That also has changed. Starting in 2016, qualified small businesses can use the credit against the employer portion of payroll tax up to $250,000 per year. A qualified small business is a corporation or partnership with sales for the tax year of less than $5 million, and no sales for any of the tax years preceding the five tax year period ending with the tax year. Put simply, a taxpayer making this election in 2016 cannot have had any sales in a year prior to 2012. 
 
A small business that is not a corporation (sole proprietor) would take into account all sales in carrying on all its trades or businesses. Companies can claim the credit against their payroll tax for no more than five tax years. This provision is aimed at small businesses still in their start-up phase by giving them a break on payroll tax.
 
What Does CohnReznick Think?
To manage risk, small businesses with no tax liability should at least consider documenting their development efforts in the earlier years before operations get too big, key employees leave, and documentation can no longer be found.
 
The PATH Act finally provides businesses with certainty with a permanent R&D tax credit and small businesses now have more options to make use of the credit. Coupled with guidance from the recent IRS and Treasury regulations, the credit is definitely headed in the right direction.
 
Companies should consider the R&D tax credit as a starting point for other beneficial tax savings opportunities. Companies may also be eligible for the Sec. 199 manufacturing deduction, cost segregation for new or expanded research facilities, and current deductions for prototype development under the new Sec. 174 regulations. Other tax savings may be found in the newly proposed regulations easing the definition of internal use software for the research credit, and state sales and use property tax exemptions for R&D equipment.

 
Learn More
 
The R&D tax credit is a complex area in the tax code, even with recent regulations issued by the IRS and Treasury. CohnReznick recommends working with experienced professionals who focus in this area.
 
To learn how the R&D tax credit could help your business, please contact Scott Hamilton, R&D Tax Credit Practice Leader, at scott.hamilton@cohnreznick.com or 310-843-8226.
 
For more information, visit our Research and Development Tax Credits webpage.


Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

Search Our People

Search Our People

Look ahead. Gain insight. Imagine more. Is your business ready to break through?

View our new TV commercial..

Industry Outlooks

Industry Outlooks

Gain insight into what is ahead for the Commercial Real Estate, Technology and Middle Market Private Equity industries.

READ MORE

Learn about our upcoming events.

READ MORE

Working With Us

Working With Us

What makes CohnReznick different from others in our profession? And what should our clients come to expect when working with us? The answer is The CohnReznick Advantage. Contact us to learn how we can out the CohnReznick Advantage to work for your business.


People

The value of an organization is determined by the skills and qualities of its leaders. With more than 280 partners serving clients nationwide, CohnReznick is renowned for the diverse experiences, knowledge and backgrounds of its leadership.

Learn More

Services

We align our services in three segments: Accounting and Assurance, Tax, and Advisory. This approach allows us to provide holistic solutions to complex business problems and to seize upon opportunities requiring an integrated approach.

Learn More

Industries

Accounting and tax issues different significantly based on an organization's industry. We provide clients with expertise in nearly two dozen industries – we know the opportunities, the obstacles, the competitive landscape.

Learn more

Insights

CohnReznick professionals are thought leaders in their industries. Clients benefit from relevant and timely economic, legislative and industry insights that can keep them a step ahead of competition.

Learn More

Global Reach

Our involvement in the Nexia International network of firms enables us assist our clients wherever they do business-providing local expertise and connections wherever they needed. Nexia is comprised of 20,000 professionals operating in over 100 countries.

Learn More