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R&D Tax Credit Update: New Refundable and Creditable Options for Small Taxpayers

Rödl & Partner Tax Matters Vol 2016-11, republished in July 2024

At the end of 2015, President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”). For the first time in its long history, the Research and Development Tax Credit (“R&D credit”) was permanently extended. In addition, several provisions were enacted that modify the credit beginning in 2016.

Generally, the amount of the R&D credit is 20% of the excess of current year R&D expenditures over a certain base amount. Some simplified calculation methods are available for businesses without a traditional base period or for start-up companies. In addition to making the credit permanent, the PATH Act made the credit available to more businesses, including start-up companies, through more credit options and refund opportunities.

R&D Credit Against Alternative Minimum Tax (“AMT”)

An “Eligible Small Business” may use the R&D credit to offset Alternative Minimum Tax in addition to its regular tax liability. An Eligible Small Business is a non-publicly traded corporation, partnership or sole proprietorship whose average annual gross receipts for the three preceding years is less than $50 million. For businesses emerging from net operating losses, this new R&D offset against AMT allows use of the credits earlier than previously available.

R&D Credit Can Be Refundable for Start-Up Companies

Certain Qualified Small Businesses (“QSB”) may elect, for any tax year, to apply the R&D credit against the employer’s Social Security portion of the employer’s payroll tax (i.e. FICA) liability. The payroll tax offset is limited to $250,000 in any one year. The new rule defines a QSB as a business whose gross receipts for the taxable year are less than $5 million, and the business has not had any gross receipts for any tax year before a 5-year period prior to the current tax year in which the credit is being claimed. For example, assume NewCo begins development of a product in 2016 and has no gross receipts in 2016 and 2017. The first sale of the product occurs in 2018 with total sales that year of $3 million, followed by sales of $4 million in 2019 and $8 million in 2020. NewCo is a QSB in 2016 through 2019 because it meets the two requirements of gross receipts less than $5 million in the current year and the business had a year without any gross receipts within a tax year prior to the years 2016 through 2019. NewCo is no longer a QSB in 2020 because it has exceeded the $5 million gross receipt threshold.

A taxpayer can only elect the refundable credit for a maximum of 5 years. This rule includes members of a controlled group of businesses. Using the example above, if NewCo forms a wholly-owned subsidiary in 2020 that begins development of a new product, the subsidiary cannot claim refundable R&D credits for their expenses, even if they meet the definition of QSB in 2020.

To claim the credit, a business must make the election on their tax return specifying the amount of the credit to which the election applies. Since the refundable election is effective for tax years beginning after December 31, 2015, qualifying R&D expenses in 2016 are eligible for the election, resulting in a refund in the first or second quarter of 2017 at the earliest.

We expect that some businesses who previously chose not to undertake R&D tax credit studies because of the lack of current year cash flow opportunities can now realize a positive cash impact from claiming these credits. If your business is interested in exploring these options, please speak with your Rödl & Partner representative.

This publication contains general information and is not intended to be comprehensive or to provide legal, tax or other professional advice or services. This publication is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Consult your advisor.

We have made reasonable efforts to ensure the accuracy of the information contained in this publication, however this cannot be guaranteed. Neither Rödl Langford de Kock LP nor any of its subsidiaries nor any affiliate thereof or other related entity shall have any liability to any person or entity which relies on the information contained in this publication, including incidental or consequential damages arising from errors or omissions. Any such reliance is solely at user's risk.

Any tax and/or accounting advice contained herein is based on our understanding of the facts, assumptions we have been asked to make, and on the tax laws and/or accounting principles in effect as of the date of this advice. No assurance is given that the conclusions would be the same if the facts or assumptions change, or are not as we understand them, or that the tax laws and/or accounting principles will not change subsequent to the issuance of these conclusions. In addition, we do not undertake any continuing obligation to advise on future changes in the tax laws and/or accounting principles, or of the impact on the conclusions herein.

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