The R&D tax credit, established by the Economic Tax Recovery Act of 1981, is a strong financial incentive that companies in a wide variety of industries use to lower tax liability and free up additional capital for their business. However, while many businesses can generate a tax credit, the question of how much credit a business can use in any given year remains. The R&D tax credit utilization rules have changed in the last few years, and eligible small businesses can reap an even larger financial reward moving forward.
General Utilization Rules
The R&D tax credit is a Section 38 general business credit and taxpayers utilize this credit like any other credit under Section 38. Because the R&D tax credit is nonrefundable, the credit cannot be used to take tax liability below zero. Taxpayers can use the R&D tax credit to offset tax that exceeds the tentative minimum tax. If a taxpayer is paying alternative minimum tax for that given tax year, then no credit is allowed against tax liability because the liability is already below the tentative minimum tax. For tax years where the credit is not allowed or cannot be fully utilized, the credit may be first carried back one year, then carried forward for up to twenty years until the credit had been used.
Eligible Small Businesses
An eligible small business, defined as a non-publicly traded corporation, partnership or sole proprietorship with an average of $50 million or less in gross receipts over the prior three years have been given extra utilization potential for tax years 2016 moving forward. These eligible small businesses can now use the tax credit to offset alternative minimum tax and reduce their tax liability even further. The new limitation on the R&D tax credit for these businesses is 25 percent of so much of the taxpayer’s net regular tax liability as exceeds $25,000. This new floor is extremely powerful because taxpayers with less than $25,000 in tax liability can now reduce their taxes down to zero.
Qualified Small Business
For startup companies, the ability to offset payroll taxes can provide the much-needed capital to survive in today’s business environment. To be considered a qualified small business, the business must be a corporation, S-corporation, or partnership and pass a two-prong test having gross receipts of less than $5 million for the tax year and no gross receipts for any tax year before the 5-tax-year period ending with the tax year. If these two tests are met, a qualified small business can specify up to $250,000 of the research credit against the employer portion of social security liability.
Even though the research credit calculation can yield a large benefit in any given year, there are limitations to how much credit a taxpayer can use. However, for tax years 2016 moving forward for eligible small businesses, the dreaded alternative minimum tax can now be conquered with the R&D tax credit to lower tax liability and put more money in the hands of the taxpayer.