R&D Tax Credits Bring More Value Than Before

Few incentives have received the kind of constant press that the federal R&D Tax Credit has enjoyed over the last few years. A temporary tax credit, the research and development tax credit continues to be renewed every couple years yet can’t find enough support to be made permanent.

In the past, the R&D Tax Credit (as well as other tax credits under Section 38 of the Internal Revenue Code) has helped businesses but has been unable to affect the Alternative Minimum Tax (or AMT for short) until now.

The Game Has Changed

In September, 2010, the Small Business Jobs Act made most tax credits under Section 38 able to be used against AMT. Prior to this change, a taxpayer taking an R&D Tax Credit extension could use the credit to offset regular income taxes either at the corporate level or personal level (assuming the company taking the credit was a pass-through entity such as an S-Corp) but could not use the credits to offset their AMT tax. Because AMT affects so many taxpayers today, it was not uncommon for the taxpayer to get a little benefit from the R&D Tax Credit and see most of the credit carried forward to be used in future years. With the change due to the Small Business Jobs Act, R&D Tax Credits can now be used to reduce or eliminate a taxpayer’s AMT. The difference is staggering and truly makes a meaningful impact for a US taxpayer.

Big Tax Benefit for Small Businesses

Let’s look at an example:

A US manufacturing company with $5 million in gross revenue manufactures innovative products for the biotechnology sector. Let’s assume the company is profitable and meets the requirements for an R&D tax credit. For this example, the company generates a profit of $250,000 for the owner and is structured as a Subchapter S corporation, passing all profits and tax credits through to the owner. The company generates an R&D Tax Credit of $45,000.

The owner of the company, on his personal tax return, reports the company profit as well as tax credits and as a result, generates a regular income tax liability of approximately $77,500. His AMT tax is calculated at $68,750 leaving a difference between regular tax and AMT tax of $8,750 (these are approximate tax amounts used only to demonstrate the impact of the tax law change).

Under prior tax law, the taxpayer could use $8,750 of his R&D tax credit reducing his tax liability to $68,750.

Under the changes resulting from the Small Business Jobs Act, the taxpayer would be able to use all of his R&D tax credit, reducing his tax liability down to $32,500.

What does this difference mean in terms of impact?

The taxpayer could hire another employee, purchase a piece of capital equipment, invest in a new direction or market for his company or many other growth strategies to build his company. In each case, the result means more jobs, output or growth….that is the game changing impact for US small businesses.

About the author:

Randy Eickhoff, C.P.A. is President of Acena Consulting. With more than 20 years of tax compliance and consulting experience, Randy focuses on helping companies successfully document and secure tax incentives throughout the US. He has been a long-time speaker nationally as well as conducted numerous training sessions on R&D tax credits and other US tax incentives.