The landmark Tax Cuts and Jobs Act (TCJA) should make taxation strategy a top priority for many South Florida businesses. With its numerous ramifications, the new law is a reminder that tax can be a significant driver of value for organizations of all sizes, including businesses in South Florida’s flourishing tech and startup ecosystem.
Businesses and entrepreneurs in the technology, life science and software fields, as well as many manufacturers, will be happy to hear that one of tax law’s most important value creators, the research and development (R&D) tax credit, not only survived the overhaul but emerged as even more valuable and useful than before.
This is great news for the growing number of South Florida organizations that invest heavily in innovation. Here’s why.
Increased net value: Following the tax act’s reduction of the corporate tax rate from 35 percent to 21 percent, the after-tax cash benefit of the R&D tax credit will increase. This might sound counter-intuitive, but that increase is the result of businesses being required to reduce the amount of research and development expenditures they deduct from their taxable income by the amount of their R&D credit. Applying the lower 21 percent rate to the disallowed deduction results in a larger net benefit. For example, pre-TCJA, an R&D tax credit of $500,000 would yield a net benefit of $325,000. Post-TCJA, this credit now generates a net benefit of $395,000, a 21.5 percent increase.
This increase in the after-tax cash benefit of the R&D tax credit will also apply to the many South Florida businesses structured as pass-through entities that are not taxed at the corporate level, and therefore do not benefit directly from the 35 percent to 21 percent rate decrease. By electing what is called a “reduced” R&D tax credit, a pass-through can take advantage, indirectly, of the new 21 percent corporate rate and flow to its owner(s) a larger credit than it was able to under the prior law. The wider gap between the top individual marginal and corporate rates under the new tax act will make this election even more strategic for most pass-through companies.
Increased utilization: The TCJA will increase the overall utilization of the R&D tax credit. The elimination of the corporate alternative minimum tax (AMT), which prevented certain corporations from using their R&D credit, will open the door to more companies deriving immediate value from the credit. For pass-through entities, the increase of the AMT exemptions for individual taxpayers will also improve credit utilization.
Moreover, the TCJA limits the deductibility of net operating losses generated after December 31, 2017. Looking ahead, businesses will only be able to offset up to 80 percent of their taxable income using net operating losses arising after 2017. This new limitation could be significant for many South Florida tech companies that are on verge of significant revenue growth. Their R&D tax credit could now be useful much earlier than initially anticipated and applied against the balance of taxable income that cannot be offset by their net operating losses.
Immediate value for startups: The TCJA preserves the Qualified Small Business Payroll Credits made available to certain startups by the 2015 PATH Act. It means that startups with less than $5 million in revenue can capture their R&D tax credit and, in the absence of an income tax liability, immediately apply the credit to offset up to $250,000 in payroll taxes. No more need to carry-forward the credit with no utilization in sight.
Applying the credit against payroll taxes is as close as it gets to a fully refundable credit. South Florida startups should not overlook this opportunity any longer.
Future amortization of R&D expenses: On a slightly less favorable note, the TCJA calls for the amortization, over five years, of all research and development expenditures, starting in tax year 2022. This means that companies will not be able to immediately expense all their R&D costs as is currently the case.
The same treatment will also apply to costs paid or incurred for the development of software. It remains to be seen if this provision will be modified again before it kicks in in 2022.
Overall, the new tax law is good news for South Florida businesses on the R&D front. Companies conducting research and development should contact a tax professional with experience in claiming and documenting the R&D tax credit to learn more about the new tax savings opportunities that may be available for their business.