2016 Updates to the R&D Tax Credit
In December of 2015, Congress permanently extended the R&D tax credit through the Protecting Americans from Tax Hikes (PATH) Act. The Act contains several exciting updates to the R&D credit, including offsets to Alternative Minimum Tax (AMT) and payroll tax for eligible taxpayers. Beginning in tax year 2016, new businesses and start-up companies may be eligible to apply for, and utilize, R&D tax credits to offset payroll tax for up to five (5) years. Additionally, taxpayers who are subject to AMT and thus could not previously apply the R&D credit towards their personal income tax liability can now take full advantage of the credit starting in tax year 2016.
New Payroll Tax Offset
Beginning tax year 2016, a Qualified Small Business can offset its portion of the Social Security or old age, survivors, and disability insurance (“OASDI”) tax equal to 6.2% of covered wages with Research and Development tax credits. To be considered a “Qualified Small Business”, a company must have:
- Gross receipts for five years or less (effectively from tax year 2012 and on). However, companies that were established before 2012 but had no gross receipts until 2012 may still qualify.
- Less than $5 million in gross receipts in tax year 2016 and for each subsequent year the credit is elected. For businesses started in 2016, gross receipts must be less than $5 million when annualized for twelve (12) months. Gross receipts of businesses under common ownership are combined for purposes of this provision. Gross receipts can be found on Line 1c of the federal income tax return but be advised that the Internal Revenue Service (IRS) and Treasury Department have full discretion to create or modify regulations that may alter the definition of “gross receipts”.
- Qualifying R&D activities and expenditures.
The maximum amount that a Qualified Small Business can offset its payroll tax liability under the Act is $250,000.
In order to take advantage of the new payroll tax offset, the credit must be calculated and shown on Federal Form 6765, Credit for Increasing Research Activities, and also be included on the taxpayer’s 2016 federal income tax return. The 2016 Form 6765 contains a new Section D, Qualified Small Business Payroll Tax Election and Payroll Tax Credit, for taxpayers to elect and compute the small business payroll tax credit. The tax credit amounts then flow through to the new 2017 Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. This form is used to determine the amount of the credit allowable for the credit period and is filed in conjunction with Form 941, Employer’s Quarter Federal Tax Return. The IRS released the draft 2017 Form 941, which adds new lines for inputting the credit amount from Form 8974. Eligible taxpayers may utilize the payroll tax offset on a quarterly basis beginning in the first quarter after filing their federal income tax return. Unused credits are carried forward to each subsequent quarter and utilized until exhausted. Taxpayers who file their 2016 federal income tax returns on March 15, 2017 may apply the payroll tax offset to the second quarter and realize the benefit as early as July 2017. Companies planning to take full advantage of this special provision should plan to file their federal income tax returns on or before March 15, 2017 to begin offset their payroll taxes in the subsequent quarter’s payroll tax filing. Furthermore, taxpayers may henceforth elect the payroll tax offset on timely filed returns only and not on amended returns.
Alternative Minimum Tax Offset
Prior to 2016, owners of small to middle market pass-through entities (i.e., shareholders, members, and partners) paying Alternative Minimum Tax were effectively precluded from utilizing the R&D tax credit. Fortunately, the recent changes under the PATH Act permits certain eligible taxpayers to offset their tax liabilities below the tentative minimum tax threshold beginning tax year 2016. Per the new changes, the eligible taxpayer’s tentative minimum tax is treated as zero when computing the general business credit limitation and allows the R&D credit to be utilized. The only requirement to be eligible for the AMT offset is that the company’s average gross receipts must be less than $50,000,000 for the three (3) prior years. The new change is a significant one for small to middle market companies and companies that previously were limited in utilizing the credits due to the AMT limitation should revisit this lucrative tax benefit.