Good News for Small Businesses
When can you recall new tax laws being good news for manufacturing? U.S. manufacturers and technology companies are only beginning to realize that federal income tax provisions contained in the Protecting Americans from Tax Hikes (PATH) Act of 2015 are certainly worth being excited about. The PATH Act, which was signed into law in December 2015, made the R&D tax credit a permanent piece of the federal tax code and created additional benefits for small and startup companies.
What is the R&D tax credit?
The Internal Revenue Code allows companies an income tax reduction equal to a portion of the costs associated with their product, process, and software development efforts. The credit, which was inaugurated as a temporary measure in 1981, required Congressional extensions every year or so since inception. The often lengthy renewal periods created substantial confusion and uncertainty for business leaders regarding strategy and tax planning. The long-awaited permanency of the credit now provides manufacturing and technology companies the fiscal certainty necessary to make important decisions concerning the investment of resources for development and innovation purposes without heed of Congress’ political whims.
Alternative Minimum Tax Implications
In addition to extending the R&D tax credit indefinitely, the landmark bill allows eligible small businesses to use the credit to reduce alternative minimum tax (AMT) as well as regular tax. This change in the tax law will have a profound effect on S-corporations and limited liability corporations for their returns filed for 2016 and subsequent years. The income tax benefits for these entities were severely limited by AMT in prior years. Eligible small businesses are defined as corporations, partnerships, and sole proprietorships that had average gross receipts of $50 million or less during the prior 3 years and where the corporation’s stock is not publicly traded.
Payroll Tax Offset
The PATH Act also provides tax relief for startup companies engaged in innovation, allowing qualified small businesses to offset a portion of their payroll taxes using R&D credits. Businesses interested in saving payroll tax dollars should understand these key points:
- Beginning in 2017, qualifying businesses may offset the 6.2% FICA portion of their payroll taxes using R&D tax credits claimed on their 2016 and future federal returns.
- Qualified small businesses are defined as corporations or partnerships having gross receipts of $5 million or less during the taxable year, and that did not have gross receipts for any year preceding the 5 year period ending with the taxable year.
- R&D tax credits are applied against quarterly payroll tax payments. In any given year, the maximum payroll tax offset allowed is $250,000.
- Payroll tax savings can be realized as soon as April 2017, once the corporation’s 2016 federal return has been filed.
- Unused credits can be carried forward and used against future payroll tax payments.
Listen to Steve discuss this topic on the radio show Financial Focus.
Part 1 — Background on R&D Tax Credit
Part 2 — Company Examples of R&D Tax Credit
Part 3 — Added Provisions to R&D Tax Credit
Business principals interested in the new R&D tax credit provisions should speak with their corporate tax preparers or contact First Beacon for additional information.
Steve Powers is a founder of First Beacon Business Advisors and also president of Intrepid Advisors, a specialized business advisory firm offering expertise and consulting services relating to federal and state Research & Development Tax Credits.