Overview of the R&D credit. The research and development (R&D) credit incentivizes companies to invest in innovation in the United States. The credit is available to companies in nearly any industry that develop new products or processes or improve upon existing products or processes. Companies can claim wages, supplies and contract research costs associated with qualifying R&D projects and activities — referred to as qualified research expenditures (QREs).
Previous limitations in claiming the credit. Startup companies and other small businesses have often been limited in their ability to claim the R&D credit in the current tax year, despite having qualifying R&D activities and corresponding QREs, due to either net operating losses or alternative minimum tax (AMT) positions.
New rules provide significant opportunity. The PATH Act of 2015 included several important changes that positively affect businesses of all sizes. However, the new rules are the most substantial for startup companies and small businesses that would otherwise be limited in taking immediate advantage of the R&D credit.
R&D credit is now permanent. With a permanent R&D credit eliminating the uncertainty surrounding the availability of the R&D credit, taxpayers can more effectively plan and commit to long-term investments in R&D and innovation.
Small businesses can offset the R&D credit against AMT liability. Eligible small businesses include sole proprietorships, partnerships or nonpublicly traded corporations with average annual gross receipts of less than $50 million for the prior three tax years. The ability to offset the credit against AMT liability removes a major obstacle associated with utilization of R&D credits, particularly for owners or members of pass-through entities.
Certain small businesses can offset the R&D credit against payroll taxes. Since the R&D credit is nonrefundable, this provides a significant cash-flow opportunity for startup companies that do not have current income tax liability to otherwise offset the credit. Up to $250,000 of annual federal R&D credits can be allocated against the employer portion of FICA payroll tax liability. Qualified small businesses include corporations (including an S corporation) or partnership that: (1) have gross receipts of less than $5 million for the credit-claiming year and (2) did not have gross receipts in the current year and the prior four tax years.
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