As a business owner or operator, you understand that business growth comes in different shapes and sizes. A key component of business growth is a sound tax strategy. Every business has a unique tax situation but if you are a company that performs research and development (R&D), understanding the tax rules applicable to R&D is necessary to maximizing the benefits from those activities. Navigating tax laws and regulations through an experienced tax partner can make all the difference in moving forward or falling back. Businesses today face many competitive burdens and challenges, including our country’s complex regulatory tax environment. Many changes are occurring now that will help businesses succeed. One of the more recent significant changes for companies engaged in R&D took effect at the end of 2015. Our federal government took steps to assist businesses and business owners by extending a number of federal tax benefits and placing into law new, beneficial provisions which take effect in 2016 and beyond.
When Change is Good
Since state corporate income tax stems largely from the states’ adoption of the Internal Revenue Code (IRC), these federal income tax changes and provisions will impact corporate taxpayers at both the federal and state level. The legislation, officially signed by President Obama into law, was effective December 18, 2015. The signed bill is referred to as “Protecting Americans from the Tax Hikes (PATH) Act of 2015” (Path Act).
One of the more impactful items coming from the Path Act was the modification to the research and development (R&D) credit under IRC Section 41. The Path Act has made the R&D credit permanent, beginning in 2016. Among other provisions, the Path Act also retroactively extended existing beneficial provisions related to bonus depreciation, and provides relief for certain taxpayers subject to the alternative minimum tax (AMT).
The R&D Tax Credit
For all companies that perform research and development, the R&D credit is available to provide relief for the extensive costs that companies incur when bringing products or methods to market. Historically, certain companies that incurred R&D costs had difficulty obtaining benefits from the prior R&D credit, as the credit could only be utilized against positive income (i.e. profit). As many companies take several years to turn a profit, the R&D credits they had earned became “trapped” and unusable by the entity (or subsidiary) that generated them. This potential for trapped or unusable credits had caused uncertainty regarding the effectiveness of the R&D credit and potentially impacted decisions on whether to invest in R&D. Without a way to offset the extensive costs of R&D activity, many taxpayers simply could not afford to invest the level of resources required to either establish new, innovative products or to improve existing products.
In order to provide relief for taxpayers with R&D activity, the Path Act provides two separate avenues that qualified taxpayers can take in order to offset their R&D costs. First, the Path Act permits businesses with less than $50 million in gross receipts to use the credit to offset its AMT. This is significant as historically the R&D tax credit could not be used to reduce tax liability below the taxpayer’s AMT. Since the credit could not be used to offset AMT in past years, any unused credit would be required to be carried forward to future tax years. However, with the passing of the Path Act, some corporate taxpayers can now bypass this limitation.
Second, the Path Act permits certain start-up businesses with no current income tax liability to offset payroll taxes with the R&D credit. Effective January 31, 2015, a small business may be able to apply a portion of their R&D credit (up to $250,000) against payroll tax liability. To be eligible for this option a business must meet certain criteria regarding gross receipts. This is significant for startup businesses, as one of the primary costs incurred is payroll.
Due to the past limitations on the utilization of the R&D credit, many taxpayers who performed qualifying R&D activity may have overlooked credit (or refund) opportunities under the assumption that the available benefit from the credit was either non-existent, or too small to justify establishing internal procedures to perform a proper credit study. Companies that do not understand the broad nature of the activities qualifying for the credit, or the new rules related to the calculation of the credit can miss significant credit and refund opportunities for open tax years.
The federal bonus depreciation provisions allow companies to increase or accelerate the depreciation of qualified business property. The Path Act not only extends the bonus depreciation provisions, but removes some provisions that previously limited the availability of the deduction. At the federal level, the Path Act retroactively extends the 50 percent bonus depreciation for certain qualified property placed in service over the next five years (i.e., through 2019). The bonus depreciation percentage that is allowed will decrease incrementally through 2019. For example, the 50 percent bonus depreciation continues for 2015, 2016, and 2017, but drops to 40 percent in 2018 and 30 percent in 2019. Beginning in 2016, the Path Act also allows bonus depreciation to be claimed on qualified improvement property regardless of whether the property is subject to a lease, and removes the requirement that an improvement be placed in service more than three years after the building was placed in service.
At the state level, the availability of the bonus depreciation provisions is less clear. Since the bonus depreciation provisions were added to the IRC, they have not been uniformly adopted by the states, and the available benefit for taxpayers will require a state-by-state analysis. Some states have what is known as “rolling conformity” and have already adopted bonus depreciation (without modification). However, taxpayers must determine the state-specific conformity dates to confirm that a given state originally adopted bonus depreciation. Otherwise the bonus depreciation extension will not have any impact at the state level. For states that never adopted federal bonus depreciation (or adopted it with modifications), it is presumed that the bonus depreciation extension under the Path Act will have little or no impact.
AMT Credit in Lieu of Bonus Depreciation
The Path Act retroactively extends through 2019 the election to accelerate some AMT credits in lieu of bonus depreciation and, beginning in 2016, increases the amount of unused AMT credits that may be claimed in lieu of bonus depreciation. As with the bonus depreciation provisions, generally speaking, the states with rolling conformity will incorporate this change. In addition, states that do not conform to federal AMT provisions (or incorporate federal AMT provisions with modifications) would not be impacted by the changes introduced in the Path Act.
If any of these scenarios apply to your business, we are ready to help you navigate the regulations in these areas.