We’ve been waiting for so long for the R&D tax credit to become a permanent tax incentive and with the signing of the PATH Act, that dream became a reality. More importantly, this lucrative tax incentive becoming permanent is the change for small businesses that allow the R&D tax credit to be used against Alternative Minimum Tax.
Before we look at the specifics on how a small business can take advantage of this incredible opportunity, let’s review what these components mean and how they are inter-related:
Tell Me Again what is the R&D Tax Credit?
The R&D Tax Credit (found under Section 41 of the Internal Revenue Code) provides a federal tax credit for activities that develop or improve products, processes, software, techniques, formulas or incentives that are held for sale or use by customers.
While there is a lot more information and hurdles that define qualified R&D, this is a tax credit given to companies for solving problems with innovative solutions. The R&D tax credit (also known as the research tax credit, R&E tax credit, Section 41 tax credit, etc.) touches technology, software, manufacturing, construction, engineering, architecture, wineries and craft breweries, bio-technology, agriculture, aerospace and many other industries. If there is innovation present, there may be an opportunity to take advantage of this tax incentive.
What is Alternative Minimum Tax? I already pay income taxes.
Whether your know it or not, your CPA (or Enrolled Agent, or tax preparer) calculates your income tax in two ways. The typical calculation starts with revenues and subtracts your typical expenses to arrive at Taxable Income (yes, this is a proper noun and line item on your tax return).
At the same time, Taxable Income is then used as a starting point for an alternative calculation where some deductions are added back to arrive at Alternative Minimum Taxable Income (AMTI). One of the more common add-backs to arrive at AMTI is state taxes. In states where state taxes are higher (think California and New York), the add-back increases AMTI quite a bit. AMTI is then multiplied by either 26% or 28% (at the individual level) to arrive at Alternative Minimum Tax (AMT). If your AMT is higher than your Regular Tax, you pay the AMT amount.
Until the change in R&D tax credit (through the PATH Act), a taxpayer could use the R&D credit to reduce their Regular Tax but NOT their AMT. A company could generate an R&D tax credit based on performing qualified activities. However, it might not see any benefit if the shareholders were paying AMT or there was very little difference between their Regular Tax and AMT (assuming the company passed the credits through to the shareholders from the pass-through entity). The R&D Credits would simply carry-forward into succeeding years to be used at a later time.
Enter the PATH Act and Change to the R&D Tax Credit
Under the PATH Act, a “eligible small business” is defined as a privately-held corporation, partnership or sole proprietorship where the entities average gross receipts for the prior three years does not exceed $50 million. This definition includes all controlled corporations with common ownership of greater than 50%.
Tax years beginning after 12/31/2015, eligible small businesses can now use the R&D Credit to offset not only regular tax but AMT as well. Given the number of taxpayers (and specifically small business owners) that currently pay AMT, this change has important and economically beneficial results.
So, if your company (or client) is conducting activities that may qualify for R&D tax credits and has been unable to realize the benefits of the credit due to AMT, they may now be able to take advantage of this tax incentive.
Have more questions or need help to document and calculate your R&D tax credit? Give us a call!
At Acena Consulting, we recognize that you have a lot more on your plate than worrying about another tax credit. Our role is to bring strong tax technical knowledge, ability to build efficient processes, and answer the questions you may not know to ask.
We take this concern off your list so you can focus on your core business.
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