Refundable R&D Credit Benefits Doubling?

In late July of 2019, two Senators put aside the differences of the political parties and introduced a Bill that we can all agree upon.  On July 23, 2019 Senator Hassan (D-NH) and Senator Tillis (R-NC) introduced a bipartisan bill to expand the Research and Development Tax Credit for new and small businesses. 

The goal of the new legislation is to expand upon the benefits that were created by “The Protecting Americans from Tax Hikes” (PATH) Act of 2015.  The legislation will also further the evolution of how the R&D Tax Credit has become more taxpayer friendly with every iteration.

Although many parts of the R&D credit can be expanded, or simplified for that matter, the portion that is affected by the bipartisan bill deals specifically with the payroll tax offset, or “refundable credit,” created by the PATH Act.  The bill includes many incentives to help new and small businesses, and it expands the types of businesses allowed to receive the benefits. 

Currently, the refundable credit can only be used against the Social Security (6.2%) taxes of a company’s payroll tax, and the company’s benefit is capped at $250,000.  These limitations serve as a disincentive to many investors and keep the companies from having the ability to further invest in creating new technologies in a timely manner.

Additionally, those who qualify for the refundable credit are hindered by the restrictions of the methodologies created over twenty years ago, and without modern start-up companies in mind.  The Alternative Simplified Credit (ASC) calculation tends to be the methodology of choice of start-ups, but they are then forced to take a reduced benefit.  The ASC methodology was created when the credit was designed for established businesses, and there are limitations specifically designed to restrict new businesses that do not have an established base period.

The Senators issued a section-by-section analysis of the bill’s two sections, and the analysis is simplified as follows:

The first section of the bill:

• Doubles the refundable R&D tax credit by increasing the refund cap from $250,000 to $500,000.  Very importantly, the bill will also index the cap to inflation.

• Expands the refundability of the R&D credit to cover all payroll taxes paid by businesses, which amount to 8.25% of payroll, including Social Security (6.2% of wages), Medicare (1.45% of wages), and unemployment payroll taxes (typically 0.6% of wages).

• Extends the refundable R&D credit to more small businesses by increasing the eligibility cap to $10 million in receipts from $5 million in receipts.  (Keep in mind this is still which is lower than other small businesses thresholds used in accounting, but it is a step in the right direction.)

The second section of the bill: 

• Equalizes the alternative simplified R&D credit favored by startups with the traditional credit by increasing the alternative credit rate from 14% to 20% for new and small businesses that are eligible for the refundable credit.

• Expands the alternative simplified R&D credit for new startups and provides greater flexibility in the first five years of business.

• In the first year it claims the R&D credit, a new startup can take the full expanded 20% alternative simplified credit against current-year R&D spending.

• Then, through the first five years of profitability, a new startup without R&D spending in each of the previous three years can choose either:
  1. a 10% credit against current-year R&D, or
  2. the full expanded 20% credit for R&D spending that is above half of its previous three-year average, not counting any years without R&D spending.

These are great developments, but keep in mind, this legislation is still in the bill phase so it will be put to the test.  During the upcoming months, there will be much debate on how to replace the tax revenue that will be returned in credits, but many studies show that R&D credits stimulate the economy at a minimum of a dollar for dollar offset of tax revenue lost. 

It should also be noted that, even with these improvements, the United States’ credit will still be behind our international competitors, and the increase will only create a benefit that is half of the $1 million cap associated with the fully refundable Canadian R&D credit. 

To encourage investment from within, as well as from abroad, the credit must continue to evolve, and this bill is another step in the right direction.

As this article is intended to be brief, it is not all encompassing.  To discuss the topic in more detail, or to discuss other related topics, please call the offices of Apex Advisors, or David Porada directly at 248.259.7421.