Smaller taxpayers now are afforded greater flexibility.
The Protecting Americans From Tax Hikes Act of 2015 (PATH Act), P.L. 114-113, contained several provisions favorable to taxpayers that incur qualified research and development (R&D) expenditures. Perhaps most importantly, it made permanent the previously temporary credit for increasing research activities (R&D credit) and added provisions allowing the credit to claimed against payroll taxes. Or alternative minimum tax (AMT), advantages that eligible taxpayers may still be missing.
PAYROLL TAX CREDIT
Although an unused portion of an R&D credit can carried forward, before the PATH Act. Many small startups were unable to realize any benefit, as they operated at a loss and thus had no income tax liability to offset. A lot of such startups, moreover, incurred significant R&D expenditures. To remedy this situation, the PATH Act allows qualified small businesses (QSBs) for tax years beginning after Dec. 31, 2015. Electing to claim all or a portion of the R&D tax credit against the employer portion of Social Security taxes due. The maximum amount of the credit that can elected to offset payroll taxes in a given year is $250,000, and the election can only made for five tax years.
A QSB is a taxpayer with gross receipts for the tax year of less than $5 million that did not have gross receipts for any tax year preceding the five-tax-year period ending with the credit year. For example, a taxpayer claiming the payroll tax credit for the 2018 tax year must have had less than $5 million in gross receipts in 2018 and could not have had gross receipts in 2013 or prior. The purposes of the test, gross receipts reduced by returns and allowances and must be annualized for short tax years, and predecessors taken into account. For any person other than a corporation or partnership, only the aggregate gross receipts of the person in carrying on all of that person’s trades or businesses are considered. Organizations exempt from tax under Sec. 501 are not eligible to claim the payroll tax credit.
AMT OFFSET
Before the enactment of the PATH Act, many taxpayers also were unable to realize the benefits of the R&D tax credit in a given year due to the application of AMT liability, which the R&D tax credit could not reduce. Fortunately, the PATH Act also allows eligible small businesses (ESBs) to use the R&D credit to offset their AMT liability for tax years beginning after Dec. 31, 2015. (The legislation known as the Tax Cuts and Jobs Act, P.L. 115-97, repealed the AMT for C corporations for tax years 2018 and following and, for individuals in tax years 2018 through 2025, increased the AMT exemption amount and the exemption’s phaseout threshold.)
For this purpose, an ESB, concerning any tax year, is a non-publicly traded corporation, a partnership. Or a sole proprietorship with average annual gross receipts for the prior three years of $50 million or less. All persons treated as a single employer under Sec. 52(a) or (b) or Sec. 414(m) or (o) treated as a single taxpayer whose gross receipts must aggregated. Gross receipts reduced by returns and allowances and must annualized for short tax years. And predecessors taken into account. Additionally, if the taxpayer was not in existence for the full three-prior-year period, the average gross receipts determined based on the period in which the taxpayer did exist. In the case of partnerships and S corporations, the partner or shareholder must also meet the gross receipts test for the AMT offset to apply.
COMMON APPLICATIONS OF R&D CREDIT
To take advantage of these favorable changes, the taxpayer must first determine which its projects or activities qualify for the credit. Then substantiate a nexus between those projects and the expenses incurred. Based on the age of the business, the taxpayer must also determine a base amount under one of two available methods. Common industries that qualify for the R&D tax credit include software development, manufacturing, communications, engineering (including structural, mechanical, and electrical), and pharmaceuticals.
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