Insights: Article

R&D Tax Credit Enhanced and Becomes Permanent

December 30, 2016

It will be welcome news to many in the business community that the research and development (R&D) tax credit has been permanently extended by Congress, retroactively as of Jan. 1, 2015. The R&D credit extension, part of the Protecting Americans from Tax Hikes (PATH) Act of 2015, was signed into law by the President on Dec. 18. In addition to credit permanency, the legislation makes several important enhancements to expand how R&D credit benefits can be currently utilized by certain small businesses. 

R&D Tax Credit
The R&D tax credit was first enacted as a temporary credit in 1981. Since its original enactment, the credit has remained temporary and has expired 16 times, with only a one-year lapse in the credit from 1995 to 1996. In recent years, the credit has been allowed to expire, but has been routinely extended retroactively as part of tax extenders legislation. The credit last expired on Dec. 31, 2014, and was not in effect for 2015 until it was retroactively and permanently reinstated by the PATH Act.

Like many other tax extenders provisions, the intent of the R&D tax credit is to encourage and incentivize businesses to undertake certain behavior (in this case, to invest in R&D activities). This incentive effect had been dampened by the uncertainty companies have faced because of the temporary nature of the credit. 

At long last, the R&D credit is now a permanent provision of tax law. This certainty is a big win for businesses investing in research and development, particularly smaller businesses, as they now have an increased ability for using the credits generated.

Impact on Small to Mid-Sized Businesses
The legislation also broadens the impact of the credit for many small to mid-sized businesses. Under prior law, the R&D tax credit could only be used to offset regular tax; this rule limited many small to mid-sized businesses in their ability to use the credit if they were subject to the alternative minimum tax (AMT). This is especially true for many owners of pass-through entities. However, starting Jan. 1, 2016, "Eligible Small Businesses" will be able to use the R&D tax credit to offset AMT. An Eligible Small Business is defined as a business with less than $50 million in average gross receipts for the three preceding years. 

In addition, "Qualified Small Businesses," defined as a business with less than $5 million in annual gross receipts and having gross receipts for no more than five years, will now be able to use the R&D tax credit to offset the FICA employer portion of payroll tax. The amount of credit that can be used to offset payroll tax is capped at $250,000 for each eligible year. 

The enhanced ability for small businesses to currently use the credit should result in more immediate cash benefits for many companies, particularly start-ups, because they will not have to wait until they generate taxable income to take advantage of the credit savings.

R&D Tax Credit Administration
While the permanency of the credit and enhancements made by the PATH Act will surely be lauded by the business community, one key provision that had appeared in earlier proposals did not make its way to the final bill-the structure of how the credit is calculated remains unchanged. This means that the "Regular Credit," which can rely on comparing current year expenses to a base amount that often requires data from the 1984-1988 period remains in place. 

An "Alternative Simplified Credit" (ASC) is available and only relies on the prior three years' data to compute a base amount; however, the ASC results in a lower effective credit rate for many companies.  Previous proposed versions of the tax extenders legislation had proposed to raise the ASC to a 20 percent credit and phase out the Regular Credit. This change would have made administering the credit much easier but was not included in the extension.

A final reminder, the permanent extension of the R&D tax credit is effective as of Jan. 1, 2015; however, the enhancements that allow the credit to offset AMT and payroll tax do not go into effect until Jan. 1, 2016.

Latest Insights

July 19, 2018
Article
While it’s great to watch your team grow, hiring new employees can be a frustrating and grueling process.
July 19, 2018
Article
Often, human resources (HR) is over looked, but we’re here to tell you it’s an essential component of any organization and critically important to get right.
July 13, 2018
Article
Here are some idea for giving your new hire a smooth start into your business and alleviating stress for you.
July 13, 2018
Article
The impact of the recent SCOTUS Wayfair decision will continue to have a ripple effect on businesses and state sales tax compliance.
July 9, 2018
Article
The revenue cycle is a complex system and we have historically given much attention to the front-end and back-end while oftentimes leaving the middle functions of the cycle neglected.
July 3, 2018
Article
FASB Accounting Standards Codification Topic 606, Revenue from Contracts with Customers, provides a 5-step framework for determining revenue recognition.
July 2, 2018
Article
As part of the Tax Reform Act of 1986, the “Kiddie tax,” a taxing regime designed to make the transfer of income items by wealthy parents to lower tax paying children less attractive, was implemented.
July 2, 2018
Article
When it comes to your employees, you likely conducted interviews on them when you first hired them.
July 2, 2018
Article
Nearly ten years after the release of the initial exposure draft, FASB issued ASU 2016-02, Leases - The standard may have been issued, but the conversation about this re-write of legacy guidance has not slowed.