The Tax Cuts and Jobs Act (TCJA) created some new tax breaks for businesses while taking certain others away. But the TCJA did not touch the research credit for qualified expenses. What’s more, under another recent law, the Protecting Americans from Tax Hikes (PATH) Act, the benefits have been enhanced.
Background: The research credit, also known as the R&D credit, is generally equal to 20% of the amount of qualified research expenses for the year exceeding a base amount. The base amount is a fixed-base percentage (not to exceed 16%) of average annual receipts for the prior four years. In no case, however, can it amount to less than 50% of the annual qualified research expenses.
Alternatively, a business can elect to use a simplified credit based on 14% of the amount by which qualified expenses exceed 50% of the average qualified expenses for the three previous tax years.
However, the research credit is not automatic. The following three requirements must be met to claim the credit.
- The expense must qualify as a “research and experimentation expenditure” under Section 174 of the tax code. Such expenses include in-house wages and supplies attributable to qualified research; certain time-sharing costs for computer use in qualified research; and 65% of contract research expenses (i.e., amounts paid to outside contractors in the U.S. for conducting qualified research).
- The expense must relate to research undertaken for the purpose of discovering information that is technological in nature and the application of which is intended to be useful in developing a new or improved business component.
- Substantially all of the activities of the research constitute elements of a process of experimentation that relates to a new or improved function, performance, reliability or quality.
Note that the same or similar expenses may qualify for a research and experimentation deduction under Section 174. However, any Section 174 deduction must be reduced accordingly if you claim the research credit for the same expenses.
As with other “tax extender” provisions, the research credit has expired and been extended numerous times in the past. But the PATH Act brought it back to life for 2015 and thereafter. The credit is now a permanent part of the tax code.
Finally, the PATH Act also enhances the research credit for certain companies for tax years beginning after 2015. Notably, a start-up company may annually claim up to $250,000 of the credit against its FICA tax liability for up to five years. To qualify, the company must have less than $5 million in gross receipts for the year. Another change in the PATH Act protected some companies from the corporate alternative minimum tax (AMT). This is now a moot point since the TCJA repealed the corporate AMT.
In summary: The research credit is an important tax incentive for businesses of all sizes. Coordinate your efforts to maximize the tax benefits that may be claimed under current law. Your tax advisers can provide the assistance required in this area.
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