R&D Tax Update: New Opportunities for Businesses

Regulatory changes to the federal research credit (aka R&D tax credit) have presented a wealth of opportunity for small business and startups in many industries. Here is what business owners need to know going into tax season.

Permanency of the credit

In December 2015, after decades of temporary extensions, Congress finally made the R&D tax credit a permanent part of the tax code. Therefore you no longer need to wait for a renewal before you can start preparing your R&D tax claim for the following year.

Startup with no federal income tax liability? No problem, the R&D credit can offset payroll tax.

Also enacted in December 2015 and made effective in 2016 is the opportunity for certain small businesses and startups to apply the R&D tax credit against the 6.2% payroll tax imposed on the wages they pay to employees.

In their early inception, startups rarely have a federal income tax liability to apply the R&D credit against. In the past, many startups did not see the value in capturing a tax credit and carrying it forward in hope that it could be utilized someday. As such, they were missing out on the tax benefits of some of their best R&D years.

Starting in 2016, businesses that had no revenues prior to 2012, and no more than $5 million in revenues in 2016 will be able to apply their R&D tax credit against the payroll tax that they pay every quarter on the wages of their employees.  Capturing the R&D credit could have a direct effect on the cash flow of startups as early as July 2017.

Pass-through entity with a shareholder in an alternative minimum tax situation? Not a problem anymore.

The R&D credit captured by pass-through entities (e.g., S-corps and partnerships) flows through to their shareholders. In the past, when a shareholder had an alternative minimum tax (AMT) liability, he could not apply the credit against the AMT and was forced to carry it forward, deriving no immediate value from the credit. Starting in 2016, shareholders of businesses with an average of less than $50 million in gross receipts in the prior three years can use the R&D tax credit to offset an AMT liability.

New regulations regarding internal-use software

In the past, businesses often refrained from capturing the R&D tax credit for the development of software used internally (i.e., software not developed to be sold or marketed to third-parties) because of the more stringent tests that had to be satisfied in order to qualify for the credit.

Regulations published in October 2016 clarify that the internal-use software exclusion is limited to software used for general and administrative functions. Other software, used for instance in the delivery of a service or in the core operations of a business, might now qualify for the credit without having to satisfy the additional tests of internal-use software. Businesses developing their own software need to review their R&D tax strategy in light of these new regulations as more projects might now qualify.

Post-election perspective on the R&D Tax Credit

Although we can’t predict all the effects of potential tax reform by the new federal government, it is worth noting that Trump’s proposed tax changes includes the preservation of the R&D tax credit. Furthermore, the blueprint of the tax reform published in June 2016 by the Committee on Ways and Means of the House of Representatives also includes preserving the R&D tax credit and suggests that options to make it more effective and efficient should be evaluated.

How can I get started?

Kaufman Rossin’s R&D tax experts have years of experience helping businesses capture and defend research credits. Contact me to learn how the changes outlined above may present new opportunities for your business. Our team can assist you with substantiating the credit and guide you through the entire process.

Download our “FAQ: What You Need to Know About the R&D Tax Credit” to learn more:

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