2016 Brings Significant Changes- R & D Credit- Are You Ready To Maximize Your Tax Savings?
The Research and Development (R&D) Tax Credit is here to stay. After years of recurring expiration and renewal, the R&D Credit was finally made a permanent part of the tax code under the recently enacted Protecting Americans from Tax Hikes (PATH) Act. The new law also expanded the R&D Credit to allow certain small businesses the opportunity to apply the incentive towards their payroll tax or alternative minimum tax (AMT) liabilities. While the R&D Credit represents substantial tax savings for businesses in a wide range of industries, including architecture, engineering, and manufacturing, preparing the thorough paperwork needed to claim it may be time-consuming. Businesses should begin preparations early in order to be ready when tax season arrives. Is your business eligible to reap the benefits of the R&D Credit?
Thanks to the Protecting Americans from Tax Hikes (PATH) Act, the Research and Development (R&D) Credit is now a permanent part of the tax code and is available to a broader group of business taxpayers than it had been in the past. Signed into law on December 18, 2015, the PATH Act ended the previous pattern of almost yearly expiration and renewal that had impaired the R&D Credit’s utility since its inception in 1981. The intent of the R&D Credit is to encourage innovation and keep development jobs in the U.S. by providing a tax incentive to businesses that develop new or improved products or processes. In the past, however, businesses could never be certain the credit would be available from year to year, so they may have hesitated to incur the costs of R&D activities. Following the PATH Act, the U.S. will now be better able to compete on the world stage as it joins the majority of Western countries that already offer R&D incentives as a permanent part of their tax law.
In addition to granting permanent status, the PATH Act expanded the R&D Credit through two modifications:
- Beginning in 2016, some small business taxpayers with an average of $50 million or less in gross receipts over the past three years will be able to use the R&D Credit to offset their alternative minimum tax (AMT) liabilities. Certain aspects of how the credit may be used against the AMT remain unclear, such as how credits earned in 2015 or earlier will be carried forward and how credits earned in 2016 or later will be carried back to prior tax years. The IRS is expected to issue formal guidance on these matters in the near future.
- Since many start-up companies do not owe income taxes in their early years, some of these businesses will now be allowed to use the R&D Credit to offset their FICA payroll tax liabilities. This provision extends to businesses that have been active for less than six years and have less than $5 million in gross receipts. Businesses may only apply up to $250,000 of the credit for each eligible year no longer than a five-year period.
These two provisions significantly expand the number of businesses that will be able to reap the benefits of the R&D Credit. This generous tax incentive is available to businesses in a wide range of industries, including architecture, engineering and manufacturing.
In order to qualify for the credit, research activities must satisfy a four-part test:
- The purpose must be to create new or improve the existing functionality of a business component, such as a process, product, or software;
- The taxpayer must seek to eliminate uncertainty about the project;
- The taxpayer must evaluate one or more alternatives through a systematic process of experimentation, and;
- This process must be technological in nature and must fundamentally rely on the physical or biological sciences, engineering, or computer science.