The R&D credit is an incremental credit rewarding companies that continue to increase their spending on QRAs. The ASC example above shows how the credit amount increases each year resulting from QREs steadily increasing from Year 1 to Year 5. The credit is intended to motivate companies to increase their investment in QREs from prior years.
How is the credit applied?
The credit is a dollar for dollar credit used to offset federal income taxes owed. If no income tax is owed for the applicable tax year, the credit can be carried forward up to 20 years, reducing future income tax owed. C corporations claim the credit on their business tax return. S corporation shareholders and partners claim the credit on their individual tax returns.
The credit has generally been limited to zero if an alternative minimum tax (AMT) is owed or less than $25,000 of net tax is owed in any given tax year. However, the PATH Act of 2015 has significantly softened this limitation. Effective with tax years starting January 1, 2016, eligible small businesses can use the credit to offset AMT owed. An eligible small business is a business with less than $50 million in average gross receipts for the three preceding years. This will make the credit more available to small to mid-size pass-through business owners.
The PATH Act of 2015 also provided an alternative method to apply the credit. Effective January 1, 2016, qualified small businesses can elect to use the credit to offset a portion of their payroll tax. A qualified small business is a business has less than $5 million in annual gross receipts and has gross receipts for no more than five years. The credit is offset against the employer’s social security portion of the FICA tax with a cap of $250,000.
This is a great enhancement for start-up companies. Start-ups can now receive an immediate benefit from the credit to offset payroll tax. This is better than having to postpone this income tax offsetting credit until profitability is achieved.
Additional Benefits to Consider
The ASC can now be claimed for all open tax years. This means eligible companies can look back to prior year returns, typically the last three tax years plus the current year, to see if they qualify for potential credits that weren’t claimed when they first filed.
Many states, including Minnesota, offer the credit. It can reduce current and future state income taxes owed in addition to federal income taxes owed.
The PATH Act of 2015 also made the R&D tax credit permanent. The credit has been available as a temporary credit since 1981 and now it is finally here to stay. This perpetual nature is another great reason to consider taking advantage of the benefits of the R&D tax credit.
Corporations and partnerships can use Form 6765 ‘Credit for Increasing Research Activities’ to calculate and claim the credit. It is critical to maintain proper documentation of the qualified research activities and apply it within the letter of the law.
Want to know more about the R&D tax credit? Reach out to Redpath and Company’s Tracy Elstad today at 651-407-5836 or firstname.lastname@example.org.