What Small Businesses Should Know About the Newly Permanent Research Tax Credit

Alloy Silverstein’s Tax Tip of the Week

After years of uncertainty, the Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently extended a tax credit for research expenses for qualified small businesses.

Generally speaking, the basic research credit is equal to 20 percent of the cost of qualified in-house expenses over a base amount and 20 percent of certain outside expenses, such as the university basic research credit. Alternatively, a business may claim a 14 percent simplified credit for the three preceding tax years.

What Types of Expenses Qualify for the Credit?

They must be expenses that would otherwise be deductible as research expenses under the tax code and involve research undertaken to discover technological information to be used in developing a new or improved component for the business.

“In-house research expenses can include wages, supplies, and the right to use computers or similar equipment to conduct research,” explains Associate Partner Ren Cicalese III, CPA, MST.

“One thing to remember about this tax credit is that you do not have to be successful in your endeavors. If you spend time and money to develop or improve your products or services but fail to do so, you may still qualify for the tax credit.”

The credit had expired and been reinstated more than a dozen times since its inception in the 1980s before the PATH Act preserved it permanently. The latest version includes two key changes for small businesses.

Changes to the Research Credit

1. Alternative Minimum Tax (AMT) Liability:
   Normally, credits like the research credit may only offset regular income tax liability. Now an eligible small business may claim the research credit against alternative minimum tax (AMT) liability. For this purpose, the business must have $50 million or less in gross receipts.
2. Payroll Tax Liability:
   Similarly, a qualified small business may elect to claim the research credit against up to $250,000 in payroll taxes annually for up to five years. In this case, the company must have less than $5 million in gross receipts.

These changes are effective for 2016 and thereafter. Earlier this year, the IRS issued some guidelines on the enhanced credit on an amended 2016 return. In addition, certain additional technical requirements must be met to qualify for the credit.

While this credit has been simplified, the calculations are best left to the experts.

“If you’re thinking about taking a credit for research and development, talk to your CPA about how to track those expenses before you start the process,” recommends Ren. “Substantiation of expenses is required as part of taking this credit.”

If you have additional questions about the eligibility of your business, please contact us for guidance and application to your individual situation.

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