Provisions included in the Tax Cuts and Jobs Act (TCJA) may create opportunities for research and development (R&D) credits to be used for tax savings not previously considered. The topics listed below should be evaluated for prospects to use R&D credits:
- Tax Rates – Corporate & Pass-Through
- Alternative Minimum Tax (AMT)
- Net Operating Loss (NOL) Limitations
- Amortization of R&D Expenditures
- Retention of Eligible Small Business Credits
- Retention of Qualified Small Business Payroll Credits
- Corporate tax rate is now at a flat 21 percent, down from previous top rate of 35 percent
- Pass-through tax rate deduction of 20 percent of domestic qualified business income; subject to limitation; expires after December 31, 2025
- AMT is repealed for corporations; AMT credits are refundable from 2018 through 2021
- AMT higher exemption for individual taxpayers; expires after December 31, 2025
- NOL deduction is limited to 80 percent of taxable income for losses arising in tax periods beginning after December 31, 2017; no carryback and indefinite carryforward for losses arising in tax periods ending after December 31, 2017
- Amortization of certain R&D expenditures (including software development costs) would be required for tax periods beginning after December 31, 2021. These R&D costs would be required to be capitalized and amortized over a five-year period.
Note: Current efforts are underway to postpone or eliminate enactment of the Internal Revenue Code (IRC) Section 174 provision.
Potential Tax Savings
Increase in Credit from Lower Tax Rate
The TCJA lowered the corporate tax rate from 35 percent to 21 percent, which increases the research credit’s net benefit from 65 percent to 79 percent. Typically, taxpayers will use a reduced credit election under §280C(c)(3), which is generally equal to the research credit subtracted by the product of the research credit and the maximum corporate tax rate. Under §280C(c), the benefit was calculated using the maximum corporate tax rate at the time. The reduced credit is an option to avoid reducing allowable deductions for IRC §174 expenses by the amount of the research credit.
It may now be more beneficial to forgo the reduced credit election and claim a higher credit while reducing deductions. The credit is a dollar-for-dollar benefit that will offset tax liability at a lower rate. It’s worth running the calculation on the tax return to reduce allowable deductions for R&D expenses to account for possible increased savings by not using the reduced credit.
Increase in Credit Opportunity from Corporate AMT Elimination
The repeal of the AMT provision for corporations may now allow them the opportunity to offset their federal income tax liability with R&D credits.
There’s one caveat, however: IRC §38(c) allows the credit to reduce a taxpayer’s liability down to 25 percent of the amount of the net regular tax liability that exceeds $25,000.
Increase in Credit Opportunity from Higher AMT Exemptions for Individual Taxpayers
Individual taxpayers may now have a new opportunity to offset the AMT with R&D credits due to a higher exemption threshold. Individual taxpayers are now likely to use more of the R&D credits passing through to them from their businesses.
Increase in Credit Opportunity from NOL Limitation
Taxpayers may find the R&D credits beneficial to offsetting tax liability, since the NOL limit is now 80 percent of taxable income for losses arising in tax years beginning after December 31, 2017.
Retention of Eligible Small Business Credits
The Protecting Americans from Tax Hikes Act of 2015 allows corporations or owners of pass-through companies with average annual gross receipts of $50 million or less for the prior three years to use R&D credits to offset the AMT for 2016 and forward. This provision remains intact with the TCJA. The corporate AMT was eliminated, but the AMT for individuals was not. This provision positively affects flow-through entities with less than $50 million in gross receipts, thereby allowing individual shareholders to offset the individual AMT with R&D tax credits.
Retention of Qualified Small Payroll Credits
Corporations, partnerships or individuals with tax year gross receipts of $5 million or less and no gross receipts prior to five years preceding the current/claim tax year can offset up to $250,000 in payroll taxes.
The election to use the R&D tax credit against payroll taxes must be made on an original return beginning in 2017.
Looking to the Future
As a result of the TCJA, there are new tax savings opportunities through R&D credits not contemplated before. The R&D tax credit remained intact, and tax reform is making it easier to see benefit in multiple situations.
For more information on how you could benefit from R&D tax credits, contact Jason or your trusted BKD advisor.