The 280C(c) election is an important filing consideration that businesses making R&D tax credit claims need to keep in mind. This choice can have a significant impact on the number of tax credits received. In this article, we will discuss what the 280C(c) election is and when it should be used. We will also look at how the 280C(c) election works and help you understand how to make the right decision for your business.

What is the 280C(c) Election?

The 280C(c) election is an election made on a currently filed tax return that reduces the amount of research and development tax credit by the corporate tax rate. By making the 280C(c) election, the taxpayer is not required to add back the amount of the R&D tax credit to income (as would otherwise be required). 

The regular method for calculating the research and development tax credit is done by multiplying the qualified research expenses by 20% (after applying required limitations). The amount of the credit generated is then added back to taxable income (increasing income tax). The R&D credit is then applied, reducing tax by the amount of the credit. 

The net (or actual) benefit under this method is the amount of the R&D credit less the tax applied to the credit add-back. The higher the tax rate to the taxpayer, the higher the additional tax and lower the overall benefit.

By electing the reduced credit election under IRC Section 280C(c), there is no add-back and the research and development tax credit is calculated using 15.8% rather than 20%.

How Do I File a 280C(c) Election?

The 280C(c) election is an annual election made on Form 6765. In order to secure the election, the form must be filed on or before the tax return due date, including extensions.

When Should You Make the 280C(c) Election?

The 280C(c) election should be made when filing your federal tax return by the original due date (including extensions) if you have a federal income tax. If the taxpayer has no taxable income, no election should be made.

So Why Should You File a 280C(c) Election?

The 280C(c) election has long been a viable (yet highly underutilized) option for business owners claiming research and development tax credits.

Under Section 41, business owners leveraging R&D tax credits must add the amount of the credit to their taxable income, thus increasing their income tax by the amount of the credit times their marginal tax rate.

The R&D credit then reduces their income tax, generating an overall benefit and tax reduction. However, when making the 280C(c) election, taxpayers don't have to add back the amount of the R&D credit (reducing expenses), opting instead to take a reduced research tax credit at 15.8%. In short, rather than reducing the deduction, 280C(c) allows companies to elect to reduce the credit rather than add it back to taxable income.

Under the provision guidelines, 280C(c) effectively eliminates potential "double dipping," simultaneously preventing taxpayers from receiving both a credit and deduction on the same qualifying research and development expenses.

Tax Cuts and Jobs Act Can Change How You Claim Innovation Research Tax Credit

While business owners across multiple industries have used the 280C(c) election when filing for innovation tax credits to optimize various benefits, financial professionals and executives are suddenly taking a heightened interest in this statutory provision due to the Tax Cuts and Jobs Act (TCJA).

First passed into law by President Trump in December 2017, the TCJA is the most extensive tax reform bill passed in over three decades. The majority of the bill's provisions officially went into effect as of January 1, 2018, making all of its updated regulations viable options for both corporations and individual workers when filing this year's taxes.

The good news (for some) is that at least on some levels, the TCJA does reduce tax rates for both business owners and employees, although some may argue that the new bill benefits are decidedly corporation-centric.

Case in point: The top tax rate for individuals dipped from 39.6% down to 37%. However, under the new legislation, the highest business tax rate dropped from 35% all the way down to 21%. This is excellent for many entrepreneurs, as the substantial reduction in the corporate tax rate to 21% has a positive impact on the R&D tax credit when electing 280C(c).

So How Does 280C(c) Election Help?

Operating under the new corporate tax rates, companies claiming research and development expenses may find their tax benefit increase substantially when electing a reduced R&D tax credit under Section 280C(c). Prior to the TCJA, the reduction required when electing 280C(c) was 35%. By reducing the corporate tax rate to 21%, a 280C(c) election now requires the calculated research and development tax credit to be reduced by 21%. As a result, business owners and their financial planners in every R&D vertical should carefully analyze the new legislation to determine which filing option will deliver the biggest bang for their corporate buck when filing business returns. An analysis of each individual tax situation should be completed to determine whether a Section 280C(c) election will result in a higher overall tax reduction.

Disadvantages of a 280C(c) Election

However, it's important to note that the 280C(c) election is not without its disadvantages. If the taxpayer does not have taxable income, a 280C(c) election should not be made. While the R&D tax credits generated may not be utilized (if there is no taxable income, there will likely be no income tax (or very little tax if income has passed through to the shareholders) in the current year, it can be carried back one year and then forward to offset tax in future years. By not making a reduced credit election under 280C(c), the full credit will be available (as opposed to the reduced credit) in the future. The required add back of the amount of the R&D tax credit may not be enough to generate taxable income thereby having no tax impact.

The Takeaway?

The new corporate tax rates under the Tax Cuts and Jobs Act can have a significant impact on businesses claiming research and development tax credits, but whether or not a 280C(c) election is the right move depends on a number of factors, including profitability at the corporate level (or taxable income at the shareholder level for flow-through entities such as S-corporations or Limited Liability Companies). Business owners and financial professionals should carefully weigh all of the pros and cons before deciding whether to make a 280C(c) election.

Don't Navigate the New Corporate Tax Legislation Alone

Overwhelmed trying to keep up with the latest R&D tax credit legislation? Acena Consulting can help. We are experts in the research and development vertical, helping our partners optimize returns and minimize corporate risk. Contact us today to hear more