The research and development tax credit has always been a program of many moving parts and changing laws. First established in the 1980s, the R&D tax credit was initially viewed as a vehicle that only the largest and most elite organizations could leverage. However, like most tax legislation, the innovation tax credit has undergone rampant changes and updates over the last four decades, making it challenging for most business owners and entrepreneurs to keep up with the very latest research and development legal nuance.
The Alternative Minimum Tax
The Alternative Minimum Tax (AMT) is a supplemental income tax imposed by the federal government on certain taxpayers who have high incomes and/or large amounts of certain types of income that are not subject to the regular income tax. The AMT is designed to ensure that these taxpayers pay at least a minimum level of tax.
AMT Adjustments for R&D Tax Credits
For taxpayers claiming the R&D tax credit, the AMT would limit the amount of the credit that can be used to offset regular income tax. Prior to the PATH Act, R&D tax credits could not offset AMT.
The PATH Act changed the rules allowing the R&D tax credit to offset AMT for companies with average revenues of less than $50 million over the prior 4 years.
Federal R&D tax credits typically yield savings of 7.5% to 8% of the qualifying expenses for the tax year. The amount of the R&D tax credit can vary depending on several factors, including the type of research being conducted, the size of the company, and the amount of qualified expenses incurred.
The Evolution of the Alternative Minimum Tax (AMT)
One of the biggest challenges for taxpayers claiming the R&D credit was the Alternative Minimum Tax (AMT). Historically, businesses were unable to take advantage of the Section 41 credit if their AMT was larger than their regular tax liability. As a result, many companies engaging in qualifying research expenditures were unable to leverage the cash-infusing benefits associated with the R&D program.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 was one of the first initiatives to make significant changes in the relationship between AMT and the R&D Tax Credit. The PATH Act's favorable adjustments to the research credit helped mitigate alternative minimum tax limitations, allowing small companies to offset their AMT burden against the research and development tax credit. The PATH Act instantly leveled the benefits playing field among companies of virtually every size, allowing start-ups and small corporations navigating through AMT to finally monetize this lucrative credit.
The Tax Cuts and Jobs Acts Further Influenced R&D and AMT Relationship
The AMT for taxpayers claiming the innovation tax credit changed again in December 2017 with the passage of the Tax Cuts and Job Act (TCJA). While the TCJA reforms did not directly modify the basic foundation of the research and development tax credit benefit, it did adjust AMT regulations for both corporations and individuals.
The TCJA impact on the R&D tax credit was even more important. Prior to TCJA, expenses related to research and development efforts could be expensed or amortized at the taxpayer's choice. However, a provision in the TCJA changed this option to require all R&D expenditures be amortized over 60 months. For innovation companies that rely upon new product innovation for growth and success, this change (effective beginning in 2022) is a significant blow to their ability to compete.
However, beginning in 2018, the TCJA legislation repealed Alternative Minimum Tax requirements for C corporations, singularly eliminating AMT limitations on large companies claiming R&D program benefits.
The TCJA legislation established different standards for individual taxpayers. The reform program increased the AMT exemption amount for individuals from 2018 through 2025. As a result, AMT is no longer a barrier for LLC members, S corporation shareholders, or small business owners to monetize the R&D tax credit.
What Should You Know About AMT Restrictions?
The continuously changing tax regulations around the R&D tax credit can make it challenging to understand the true value of the R&D tax credit to you and your business. Acena Consulting can help. Our team of licensed accounting professionals specializes in research and development tax requirements, helping our clients stay ahead of evolving laws and program reforms. Contact us today to schedule an appointment with one of our leading R&D tax authorities.
