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Matthew Litz, CPA

Research Credit Retroactively Extended, Made Permanent

2016-03-02

The Protecting Americans from Tax Hikes Act of 2015 (aka PATH Act) signed into law on December 18, 2015, retroactively extended and made permanent the Credit for Increasing Research Activities, more commonly referred to as the R&D Credit.

Originally enacted in 1981 as a temporary incentive, the R&D credit had been repeatedly extended, thus creating uncertainty as to its long-term availability. The temporary nature of this credit, coupled with the Alternative Minimum Tax (AMT) limitations, not only hindered the tax planning process, but significantly diminished the tax benefit for many small businesses. Thankfully, this is no longer the case.

Small businesses need to be aware of two major changes with the PATH Act:

  1. Small start-up companies can apply the credit against payroll tax instead of income tax;
  2. Eligible small businesses may apply the credit against AMT.

The first new provision is an irrevocable election that is available to companies with gross receipts of less than $5 million, and with only a five-year history of gross receipts. Controlled groups of corporations are treated as a single taxpayer for this purpose.

The amount of the current year R&D credit that can be applied to payroll taxes is limited by prior year business credit carryforwards, if any, and cannot exceed $250,000. A few things to note:

  • Once this amount is determined (called the payroll tax credit portion), the credit is only applied against the FICA portion of payroll taxes, and can be utilized starting in the first calendar quarter after the tax year that the election is made.
  • It cannot exceed the FICA tax for that period. Any unused amount is carried over to subsequent quarters.
  • Companies are not required to reduce their payroll tax expense by the amount of this credit.
  • The election can only be made for five consecutive years, and must be made at the entity level for flow-through entities.

The second new provision in the PATH Act is the AMT offset. Essentially, the R&D Credit has been added to the list of “specified credits” that receive more favorable treatment for AMT purposes. Historically, the AMT limitations on the R&D Credit prevented many smaller companies, as well as shareholders and partners of flow-through entities, from receiving the actual tax benefit of this credit.

This new provision may now allow eligible small businesses to offset both regular tax and AMT liabilities. An eligible small business under this provision is a private corporation, partnership, or sole proprietor with average annual gross receipts of $50 million or less over the prior three tax years.

For additional insight, read Escaping the Lab: The Research and Development Tax Credit.