Earlier this week I wrote a short article on small business and the voice, or lack thereof, they have with elected officials (See Who’s looking out for small business tax incentives?). I touched on an area that I thought needed a bit more ink, namely, the relationship between the research tax credit and Alternative Minimum Tax.
As noted in my blog from last year, R&D Tax Credit Extension & AMT Relief…Finally! The Small Business Jobs Act provided a one year change that allowed tax credits under Section 38 (Internal Revenue Code) to be used against both regular and alternative minimum tax. For small businesses, this change was not only important but needed. Unless you are a CPA or spend your life looking at tax returns, you might not understand just how important this change was to small business owners.
Let’s take a deeper look and perhaps shed some light on this issue.
What is AMT?
Simply, AMT stands for Alternative Minimum Tax and is a parallel system of taxation that was enacted to make certain that everyone pays their fair share of tax. Whether you realize it or not (and if you are living in California or New York or other state with high income tax rates, you are already familiar with AMT), your tax preparer calculates both your regular tax liability and your tentative minimum tax (TMT). You pay the higher of the two amounts. AMT starts with your taxable income number and eliminates certain items such as taxes paid, some medical and dental deductions, state tax refunds, net operating loss, and many others (a total of 25 items can be found on Form 6251). Once you add back the above items the new amount is called your alternative minimum taxable income (which is typically higher than your taxable income). After a small exemption is subtracted, the remaining amount is multiplied by either 26% or 28% (26% if the amount is $175,000 or less) to come up with your TMT (I omitted a few adjustments that most people don’t see). If your TMT exceeds your regular tax, you pay the TMT.
How Do Section 38 tax credits affect AMT?
They don’t, that’s the challenge. If a company generates a research tax credit as a result of their efforts in R&D, the resulting tax credit will lower their regular tax but can’t lower their TMT. Since marginal tax rates (the actual rate paid) for many small business owners range between 25-30%, you can see that the difference between regular tax rates and TMT can be minimal and result in no ability to use an R&D tax credit. In 2010, the Small Business Jobs Act allowed taxpayers to offset their TMT with the R&D tax credit (or other Section 38 tax credits) but not before and not currently for 2011.
Make a permanent change
There is a lot of talk about making the R&D tax credit permanent (as there has been for a long time) but because there is a perception that it doesn’t pay for itself (a whole other topic or rant), lawmakers are reticent to pull the trigger and finally complete the process. I still believe they can get it done at some point and would simply ask that when they do, make it important. Make Section 38 tax credits mean something against TMT for small businesses.
If you really are serious about hitting home runs, make meaningful changes that make a difference.
What say you my friends?
What would you say to your elected officials about tax incentives?
What other incentives are you aware of that aren’t valuable due to their structure?
What is the most important tax incentive for your company?
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Randy Eickhoff, CPA is President of Acena Consulting. With more than 20 years of tax and consulting experience, Randy focused 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.