Armanino Blog

How Tax Reform Enhances the R&D Credit

by David Sheets
April 11, 2019

The Tax Cuts and Jobs Act of 2017 (TCJA) has generated a lot of buzz around ways in which it directly changed many provisions of the Internal Revenue Code. But the law’s effects on existing parts of the code can, in some cases, be just as significant as those explicit changes. One tax incentive that got an indirect boost from the TCJA was the research and development (R&D) tax credit. Here are some of the changes in the new law that made the credit more valuable:

  • Lower tax rate increases value of the credit: The R&D credit rules have always prevented taxpayers who claim the credit from also deducting the expenses attributable to qualified research activities from their taxable income. The TCJA retained this prohibition against a double tax benefit. The good news is that the reduction in corporate tax rates essentially made the credit more valuable, because the additional taxable income arising from the disallowed expenses is now taxed at a maximum of 21 percent, as opposed to pre-TCJA rates as high as 35 percent. The bottom line is that the lower tax rate increases the R&D credit’s net benefit.

  • Elimination of corporate AMT protects against reductions in the credit: Prior to the TCJA, corporations that were subject to the alternative minimum tax (AMT) could not use credits and deductions to offset their minimum tax. With the new law’s repeal of the corporate AMT, those corporations will now be subject only to regular income tax — opening up the opportunity to claim the R&D credit, as well as other incentives.

  • Eligible small-business credits: Longtime fans of the R&D credit might remember the positive changes made to the credit in a 2015 tax law. None of those changes were modified by the TCJA. One of the changes allows owners of pass-through businesses (with average revenue of less than $50 million in the previous three years) to apply the credit against their personal AMT liabilities. The TCJA eliminated the corporate AMT, but the system remains in place for individuals. Owners of pass-through entities can use the R&D credit to reduce AMT liability on their personal returns.

  • Retention of payroll credits for small-business startups: Another 2015 change allows companies with less than $5 million in annual revenue to use the R&D credit to offset up to $250,000 in payroll taxes for the first five years they have gross receipts. That rule remains unchanged by the new law.

  • Amortization of R&D expenses starting in 2022: One TCJA provision makes the R&D credit more appealing starting in 2022. The provision requires taxpayers to capitalize and amortize R&D expenditures over a five-year period (15 years if the research is performed outside the U.S.), and it takes effect for tax years beginning after December 31, 2021. Companies considering or embarking on R&D should consider whether they should accelerate activities to take advantage of the current opportunity to expense those amounts during the year in which they are paid or incurred.

As always, it’s important to evaluate any tax law in light of the specific facts and circumstances that apply to your business. Discuss with your tax advisor which credits and incentives might be right for your company.

April 11, 2019

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