Few tax provisions have received as much publicity as the dreaded alternative minimum tax (“AMT). A secondary federal tax calculation, the AMT was designed to make sure the wealthiest of Americans “paid their fair share (the top 155 taxpayers to be exact).”
While the concept of paying a fair share may be a reasonable one (a topic for another time), the design of the AMT failed in its goal of taxing only the top tier of Americans.
As we know, over time, incomes have risen and the exemption amounts for AMT have not kept pace with inflation. The result? The alternative minimum tax now impacts millions of Americans and generates billions of tax revenue for the federal government. It’s no surprise that Congress struggles to correct this additional tax.
Why is it so hard to correct? The money is already spent.
Enter the new permanent Research Tax Credit
In 2015, the PATH Act (“Protecting Americans from Tax Hikes”) was enacted making the federal research tax credit permanent. As importantly, it provided for two significant provisions that will reward the sweat equity US taxpayers put into building their businesses in developing innovative solutions.
The Unfulfilled Promise of the R&D Tax Credit:
The research tax credit has been a lucrative credit for taxpayers that develop innovative solutions for many years. Large corporations generate significant R&D tax credits and due to the structure of the corporate AMT, the credits would provide value.
For the small business however, the R&D credit brings a mixed bag of value. We could help generate both federal and state research tax credits for small businesses but in many cases, these credits would not be used at the federal level because the research tax credit could only offset regular income tax NOT alternative minimum tax.
A small business owner spends countless hours developing a product or software or process that may change the way their clients do business. They develop a new formula that revolutionizes an industry. Congress provides the research tax credit to these businesses to help offset the cost of development.
That was always the good news.
The bad news was that if that business owner was successful and generating a reasonable return on their time and money investment ($200,000+ taxable income), he or she may find themselves paying alternative minimum tax (or being very close to paying it) and the R&D tax credit they deserved would be useless against AMT. They could carry it over for future years but that doesn’t help them hire another engineer or developer today, thus rendering the R&D tax credit an incentive that did not fulfill its promise to spur innovation through lowering taxes.
Years ago I wrote a blog about the temporary (one year) allowance to use the federal R&D tax credit to offset AMT. Yes, in 2010, there was a one-year opportunity that Congress put in place that helped our small businesses finally use the research tax credit against AMT. This was the news we (as tax professionals) had been waiting for. Finally, some relief, albeit short.
With the enactment of the PATH Act, the research tax credit finally became a permanent tax credit. Included in this new and improved R&D tax credit were two provisions that bring significant value to small businesses.
The AMT Offset!:
For privately-held corporations, partnerships and sole proprietors that have average revenues under $50,000,000 for the prior three years, the research tax credit generated can be used to offset AMT.
For those more visual learners, we developed an infographic that may help understand the requirements under this new provision. You can access it below.
The second provision relates to start-up companies and using the research tax credit against payroll taxes that we will cover in another blog next week.
Controlled Groups-The Fine Print:
A Controlled Group (as defined in the tax world) referred to a group of tax entities (corporations, partnerships, etc. where there exists common ownership of greater than 80% (tax geeks see IRC Regulations Section 1.1563-1 (a)). For the purposes of the research tax credit, however, a Controlled Group is defined as a group of entities where there is greater than 50% common ownership. I’m oversimplifying the definition but in the event a taxpayer owns or controls multiple entities, the gross receipts of all controlled entities would be added together for the gross receipts test of $50,000,000.
Upon calculation of your 2016 R&D tax credit (through a properly completed study of the company’s development activities), the credit will be available to offset your regular income tax and AMT.
The new credit is available for tax years beginning after 12/31/2015 (so it will be available this year when your R&D tax credit is completed).
With these changes comes a word of warning.
While the credit is more valuable, the IRS is still challenging taxpayers use and calculation of the R&D tax credit. If audited and not sustained, a taxpayer could be subject to penalties if the credit is disallowed or reduced substantially.
Having an expert in your corner for the research tax credit is like having a heart surgeon on hand when needed. Many times, we have been asked to assist a taxpayer with an audit where they have completed a very rough calculation with little documentation. These audits can be difficult and result in a reduced credit, interest and in some cases penalties.
We recommend utilizing the services of an expert (shameless self-promotion below) in this area in order to mitigate potential mistakes, maximize your research tax credit and develop the proper documentation. Along those lines, we have schedule a free CPE session to provide up-to-date information on the new permanent R&D Tax Credit.
You can find more information on the webinar below. I hope you will join us for this informative hour that will benefit you and your clients.
At Acena Consulting, we recognize that you, the small business owner, have a lot more on your plate than worrying about a tax credit. Our role is to bring strong tax technical knowledge, ability to build efficient processes, answer the questions you may not know to ask. We take this concern off your list so you can focus on your core business.
Want to learn more about the magic of our approach?