The largest tax cut in American history retains the R&D credit in its current form. However, several features of the Tax Cuts and Jobs Act (TCJA) could have a profound impact on companies that claim research credits and the ability to deduct research expenditures.
Following are some of the biggest changes.
Increase in Credit from Decrease in Tax Rates
Previous Law
Taxpayers couldn’t take a deduction under IRC Section 174 equal to the amount of the R&D credit. This prevented companies from getting a double tax benefit, and taxpayers were required to reduce their R&D expenses by the amount of the credit. The reduction in expenses created an increase to income and any corresponding taxes.
Taxpayers could avoid the reduction of their research expenses by electing to take a reduced credit in accordance with IRC Section 280C(c)(3). This election reduced the research credit by the amount of tax savings created by the double tax benefit. The 280C(c) benefit was calculated using the maximum corporate tax rate.
Moving Forward
Section 280C(c) was retained in the TCJA. However, since the maximum corporate tax rate is going down from 35% to 21%, taxpayers will see an increased credit.
Increased Credit Usability from Elimination of Corporate AMT
Previous Law
The corporate AMT was set to 20%. This meant that regardless of any credits or deductions, corporations would still be taxed at a minimum rate of 20%.
Moving Forward
With corporate rates going down to 21%, the AMT rate was eliminated.
Nevertheless, there’s still one limitation remaining on R&D credits to prevent taxpayers from using the credit to completely eliminate their tax liability. The rule, effectively known as the 25/25 limitation, restricts taxpayers with over $25,000 in regular tax liability from offsetting more than 75% of their regular tax liability using the credit.
Increased Credit Usability from Higher AMT Exemptions for Individual Taxpayers
Previous Law
Individual taxpayers were sometimes prevented from using the credit because of AMT at the individual level.
Moving Forward
The AMT exemptions for individual taxpayers are increasing. As a result, individual taxpayers are likely to use more of the R&D credits passing through to them from their businesses.
Retention of Eligible Small Business Credits
Previous Law
Corporations or owners of pass-through companies with less than $50 million in average revenue over the prior three years were allowed to use the R&D credit to offset AMT.
Moving Forward
Since the corporate AMT was eliminated by the TCJA, this provision will benefit individual taxpayers with R&D credit flowing through from a business that they have an ownership stake in.
Retention of Qualified Small Business Payroll Credits
Startup companies with less than $5 million in revenue will still be able to make an election that will allow them to offset up to $250,000 in payroll taxes for the first five years they have gross receipts. Starting in 2017, payroll credits must be elected on an original return.
Amortization of R&D Expenses Starting in Tax Year 2022
Previous Law
Taxpayers could choose to deduct their R&D expenses or charge them to a capital account if they make an election under IRC Section 174.
Moving Forward
After 2021, companies will no longer be able to immediately expense costs that are treated as specified 174 research expenses. Instead, they’ll be required to charge US-based research expenses to a capital account and deduct them over a five-year period. Expenses incurred for research performed outside of the United States will be charged to a capital account and deducted over a 15-year period.
Intense lobbying to eliminate or prolong this provision is expected in the coming years.
We’re Here to Help
If you’d like to learn more about how changes to research credits affect your business, contact your Moss Adams professional or email creditsandincentives@mossadams.com. You can also visit our R&D tax services webpage or our dedicated tax reform webpage to gain more insight.