In our last post, we touched on the importance of the PATH Act, which permanently cemented the R&D Tax Credit into the federal tax code and included two significant amendments designed to support small businesses- the startup provision and the AMT turn-off. Though it has been well over a year since the enactment of the PATH Act, there continues to be speculation and confusion regarding the AMT’s effect on the R&D Tax Credit. In this post, I aim to provide clarification and guidance to help you better assess whether the R&D Tax Credit is worthwhile for you.
The AMT-turnoff provision enables certain taxpayers to utilize the R&D credit to offset their AMT liability. To begin with, it is important to consider the definitions embedded within the clause. “Certain taxpayers” are limited to eligible small businesses, which are defined as: businesses that are a non-publicly traded corporation, partnership, or sole proprietorship with an average of less than $50 million in gross receipts over the prior three years. Average gross receipts, which include total sales, receipts received for services, income from investments, and proceeds from the sale of property used in a trade or business, reduced by the adjusted basis in the property, are calculated applying the rules of IRC Sec. 488(c)(2) and (3). Partners and S corporation shareholders must separately satisfy the gross receipts test in order to be eligible for the AMT offset.
This provision particularly benefits partnerships and S corporations whose partners and shareholders may be subject to AMT. Prior to the PATH Act, taxpayers paying AMT were barred from taking R&D tax credits, exposing them to a higher level of taxation, despite their qualified R&D activities. For small businesses, this restraint could have meant the forfeiture of valuable tax credits needed to reinvest into their businesses. With the passage of the PATH Act, the R&D Tax Credit is now accessible to many more small-to-midsize businesses, a change that is sure to spur economic growth and further investment into research and development among American companies.
With these new provisions effective for tax years beginning after December 31, 2015, savvy companies have already taken advantage of these benefits for their 2016 tax returns. With its increasing popularity among small to mid-size companies, now is a crucial time to determine your eligibility for the R&D Tax Credit. How do you know if you qualify? In general, any active trade or businesses that meets the four-part test is a good candidate for the R&D Tax Credit.
The four-part test is a tool used to determine qualified R&D activity:
- Permitted purpose: The purpose of the research must be to create a new or improved product or process, resulting in increased function, performance, reliability or quality.
- Uncertainty: The taxpayer must encounter uncertainty regarding the most appropriate design of the new product or process, the appropriate methodology for achieving that design, or whether they are capable of developing it at all.
- Process of Experimentation: The research must involve elements of experimentation, evaluating alternatives for achieving the desired result.
- Technological in Nature: The research must rely on principles of the physical or biological sciences, engineering, or computer science.
Companies in nearly every industry and size may meet the four-part test and be eligible for R&D tax credits. Manufacturing and software companies essentially perform R&D-qualifying activities in their daily operations, as any activity undertaken to make a product or process better, cheaper, or faster can qualify for the credit. Whatever the size or industry of your business, considering the R&D Tax Credit in your financial planning may result in a lucrative tax benefit.
For further information or a complimentary assessment of your eligibility and potential credit size, contact us today.