Since the Tax Cuts and Jobs Act (TCJA) passed in the waning hours of 2017, it has been the subject of much debate. Discussion often centers on one big question: Will TCJA lower taxes for individuals and small businesses as proponents have said it would?
One tax incentive I’m familiar with was not only made permanent a couple of years ago, but may now offer savings to taxpayers that would not previously have considered it. I’m talking about the research and development (R&D) tax credit. For a business engaged in certain research activities, the savings could now be even more significant.
R&D credit is fundamentally unchanged
The R&D tax credit is designed to give companies a credit on their federal taxes for specific qualifying activities meant to improve products and processes. It’s been around for decades in one form or another, but the credit was finally made permanent in 2015. Fundamentally, the law did not change in December, but because corporate tax rates have fallen and certain restrictions have been lifted or modified, some business owners might be surprised by the impact on their tax liability.
The intent of the R&D tax credit has always been to encourage and incentivize businesses to invest in certain activities that advance technology, improve competitiveness and (potentially) create jobs.
Impact of lower corporate tax rates
TCJA reduced the corporate tax rate from a maximum of 35 percent down to a flat 21 percent. This, in turn, improves the R&D credit’s benefit from 65 percent to 79 percent. The key is Internal Revenue Code (IRC) section 280C(c), which was originally meant to keep taxpayers from double-dipping (a deduction and credit for the same expense) when claiming the R&D credit. The law gives taxpayers the option of reducing the deduction for their qualified expenses by the amount of the R&D credit. Taxpayers also can choose a reduced credit that is equal to the R&D credit minus the product of the R&D credit and the maximum corporate rate. Thus, with the 21-percent rate now in place, the reduced credit jumps to 79 percent.
Repeal of the AMT
Also noteworthy in this discussion is the repeal of the alternative minimum tax (AMT) for corporations. Corporate taxpayers that might have previously been subject to the AMT would likely not have been able to use R&D credits to offset a part of their federal tax liability. No AMT means they might now be able to do so. The law allows the R&D credit to offset the first $25,000 of tax, plus up to 75 percent of the tax in excess of $25,000.
Limits on net operating losses
The new law limits the net operating loss (NOL) deduction for a year to 80 percent of taxable income, effective for losses after December 31, 2017. It also repeals the carryback provisions in the previous law, and provides an indefinite carryforward of NOLs arising in tax years ending after December 31, 2017. This provision highlights the benefit of utilizing as many tax incentives on the 2017 return as possible. Any losses carried forward from 2017 can be utilized first at 100 percent.
Amortization of research and experimentation expenditures
TCJA requires taxpayers to capitalize and amortize research and experimentation expenditures over a five-year period if they are paid or incurred in a year after December 31, 2021. If research is conducted outside the United States, the expenditures must be amortized over 15 years. This contrasts with previous law, which allowed taxpayers to deduct R&E expenditures in the tax year where they were incurred or paid.
Give the R&D credit another look
These and other changes give a boost to a tax strategy that was already attractive for businesses of all sizes and in all industries. Now even more may be able to turn the tax law to their advantage. If you believe you might qualify for the R&D tax credit, it would be worth your time to talk to a tax professional about your options. iBi
Mark Colvin is a principal and a national service leader in CLA’s (CliftonLarsonAllen) Federal Tax Strategies practice. He can be reached at (309) 495-8754 or [email protected].