The Research & Development (“R&D”) Tax Credit was enacted in 1981 as a temporary business credit. Since its enactment, the federal R&D tax credit has expired 16 times, only to be reenacted and extended for a short period. The federal R&D credit last expired on December 31, 2014. However, on December 18, 2015 under the Protecting Americans from Tax Hikes (“PATH”) Act of 2015, the federal R&D tax credit was made retroactive to January 1, 2015 and has been permanently extended.
In addition to the permanent extension of the federal R&D tax credit, the legislation made two key expansions to the R&D credit which benefit certain small businesses. The following changes went into effect on January 1, 2016:
- “Eligible Small Businesses” are able to use the federal R&D tax credit to offset federal alternative minimum tax (“AMT”). An Eligible Small Business is defined as a business with less than $50 million in average gross receipts for the three preceding years. Under prior law, the R&D tax credit could only be used to offset regular tax, which limited the ability of small to mid-sized businesses to use the R&D credit if they were subject to AMT.
- “Qualified Small Businesses” are allowed to elect to claim the R&D tax credit as an offset to the employer portion of FICA payroll tax up to $250,000 for each eligible year. A Qualified Small Business is defined as a business with less than $5 million in annual gross receipts having gross receipts for no more than five years. This is the first time in history start-up companies in a net operating loss (“NOL”) position are able to benefit from the R&D Credit.
There has been no change to the carryback and carryforward period for federal R&D credits, which is 1 and 20 years, respectively.
There are currently 39 states, including California that offer R&D tax credits. However, the rules for each state offering R&D credits differ from the federal rules (i.e. qualifying R&D activities, carryback and carryforward periods, characterization of credits as refundable or nonrefundable, and the utilization against AMT) and should be reviewed independently of the federal R&D credit requirements.
In light of the recent changes, taxpayers who were unable to utilize federal R&D credits previously due to AMT or NOL limitations, should reevaluate their eligibility to take advantage of these incentives.