By Dean Zerbe
When it comes to the research and development (R&D) tax credit, it’s a new world out there for U.S. startups and small businesses — and their CFOs should be getting in front of this potentially game-changing opportunity, no matter when their companies file their taxes.
In December 2015, Congress passed the Protecting Americans from Tax Hikes (PATH) Act, a landmark piece of tax law that made the R&D tax credit permanent and expanded the credit for the benefit of small businesses and startups across the country.
While permanence (and the certainty it provides when planning ahead) is a big win for U.S. businesses, two modifications made to the credit—the startup provision and the AMT turnoff —could be the biggest news in terms of stimulating job creation and economic growth.
Best of all, those amendments kick-in beginning in tax year 2016—meaning this tax season.
Almost two years ago, I testified in front of the U.S. Senate Committee on Small Business & Entrepreneurship to advocate for the startup provision to further reduce compliance burdens placed on small businesses.
With the inclusion of the following modifications to the PATH Act, it’s good to see that our policymakers came through for American businesses.
For years, one of the real shortcomings of the R&D tax credit was that its eligibility requirements essentially barred startups — some of the most innovative companies and the ones most responsible for job growth — from a credit designed to reward innovation and job creation.
How can that be? It all relates back to the mechanics of the credit.
Considering that most startups and new businesses aren’t immediately profitable, these companies traditionally don’t pay federal income taxes. Since the federal R&D tax credit is designed to lower federal income tax liability, that presents a real problem for startups in their ability to use the credit. Stated plainly and simply, if a company wasn’t paying federal income taxes, that company would be unable to benefit from the credit — even if this business was performing activities that do indeed qualify.
To address an obvious disconnect between the intent of the credit and its application, the framers of the startup provision allowed businesses with a) gross receipts of $5 million or less in the tax year of the claim and b) no gross receipts in any tax years preceding the last five years (including the year of the claim) to take the credit against payroll taxes.
The startup credit is available for up to five years (capped at $250,000 annually) and can be taken on the next quarterly payroll tax return after filing.
The turnoff of the alternative minimum tax (AMT) was originally a one-year policy fix implemented as part of the Small Business Jobs Act of 2010. That year, we saw the impact that provision had on hundreds of small and medium businesses, helping to create jobs and stimulate local economies.
An updated version of the policy was passed when the R&D tax credit was made permanent — and the new AMT turnoff is estimated to lead to a major increase in the number of small businesses that can use the R&D tax credit.
In the past, the alternative minimum tax bar in section 38(c) of the tax code has been the greatest hurdle preventing small and medium businesses from claiming the R&D tax credit. The AMT barrier has long prevented owners of pass-through entities (including sole proprietorships, partnerships, nonpublic corporations) from using the R&D tax credit to reduce their taxes below their tentative minimum tax.
Now, because of the PATH Act, the AMT barrier is effectively turned off for “eligible small businesses” (defined as businesses with less than $50 million in average gross receipts for the previous three years). The result? Qualifying companies can now use the credit to offset regular and AMT tax liability.
Combined together, these modifications to the R&D tax credit have the potential to pump millions back into the economy and bring tremendous value back to small businesses and startups — the two most important groups when it comes to promoting job creation and economic growth.
Dean Zerbe, a former senior counsel to the U.S. Senate Finance Committee, is a national managing director of alliantgroup, a provider of specialty tax services.