By Tommy Zavieh, CPA, MST, MBA
The research and development (R&D) tax credit is underutilized, with many taxpayers failing to claim the credit when they are eligible to do so, or making errors at critical junctures in the process.
Underutilization of a Major Tax Benefit
Many taxpayers do not realize that the R&D tax credit is available to businesses of all sizes in many lines of business, not just major corporations conducting tests in research laboratories. Under the current tax code, any company that develops or improves products or processes may be eligible.
IRS statistics show that R&D tax credits worth nearly $11.3 billion were claimed in 2013, the latest year for which data is available. While this sounds significant, a large number of eligible entities neglect to claim the R&D credit. One of the biggest drivers for the underutilization is likely a lack of knowledge by both taxpayers and their advisers. Many are unaware of the R&D credit; those that are aware may not believe it applies to them, and those that believe it applies to them may not believe they have enough expenditures to justify claiming it when in reality many taxpayers do qualify and will benefit significantly from an appropriately calculated credit.
Thankfully, the regulations permit eligible taxpayers to “look back” to all open tax years for potential unclaimed credits, so all is not lost if lack of knowledge precluded or limited a tax credit in recent years.
Major Legislation Affecting the R&D Tax Credit
Two major pieces of legislation in 2015 and 2017 affected the credit. The Protecting Americans From Tax Hikes Act of 2015 (PATH), P.L. 114-113, made the R&D tax credit permanent and added a provision permitting eligible startup companies (i.e., those with less than $5 million in gross receipts and no gross receipts for any tax year before the five-tax-year period ending with the tax year) to claim up to $250,000 of the credit against the employer’s FICA portion of payroll tax. (For more on the changes made in the PATH Act, see Zavieh, “R&D Tax Credit Made Permanent,” available at www.linkedin.com.) The law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, affected the credit by significantly reducing the corporate tax rate and repealing the corporate alternative minimum tax.
2019/2020 Planning Opportunity
Taxpayers cannot take both a credit and a deduction for the same research expenditures. If they wish to retain their full deduction for research expenses, they must take a reduced R&D tax credit. They can make such an election under Sec. 280C(c)(3), and it may be a desirable option in some circumstances, especially because taxpayers that elect a reduced credit will keep more of the credit than they did previously. The taxpayer will no longer trim its R&D credit by 35% but by 21% due to the lower corporate tax rate. As a result, taxpayers making the Sec. 280C election will realize an additional 21.54% of tax benefit compared to its historic treatment. For a snapshot of how the reduced R&D credit has changed, see the table, “R&D Tax Credit: Old Law vs. New Law” (below).
The Sec. 280C election must be made on an original return that is timely filed (including extensions). The election is year-by-year and, once made, is irrevocable for that year.
The PATH Act and the TCJA have had major implications for the R&D tax credit. However, despite their positive impact, each taxpayer’s situation must still be analyzed carefully to determine the most advantageous route to take.
When described in simple terms, the R&D credit sounds easy to calculate, and the instructions to Form 6765, Credit for Increasing Research Activities, are deceptively straightforward. Money is lost in the subtle complexities and nuances. Even experienced tax practitioners should consult specialists to avoid leaving tax benefits on the table.
This article originally appeared on The Tax Advisor.