Research and development tax credits can be beneficial to new and existing companies.
On the federal level, the Protecting Americans from Tax Hikes Act of 2015 brought multiple tax updates and changes, specifically to the R&D tax credit, most of which benefit small businesses.
Companies generally have three options on how to deduct R&D expenses from income.
Expenses can be deducted in the year they were paid/incurred or a company can choose to amortize the expenses over the expected life of the goal of the research. But it cannot be less than 60 months or amortized over longer than 10 years.
Regardless of which method, a company will qualify to take the tax credit in addition to the expense.
DOCUMENTATION IS VITAL
R&D expenses include any expense directly related to research and/or development, including wages, materials and contract research (up to 65 percent of total costs).
The most complicated part of this credit is having a system that can track the expenses that qualify and separate out those that do not.
Documentation is key to withstand potential audits and to extract the most credit possible.
The tax credit can be carried back one year and forward for 20 years.
The biggest impact of the PATH Act was that it made the credit permanent.
There had always been a degree of uncertainty when it came time for legislation to extend the credit. That is no longer a concern.
For small-business owners (less than $50 million in gross receipts over the past three years), the R&D credit can offset the alternative minimum tax in addition to regular tax.
For pass-through entities, such as S corporations and partnerships, this was a major change because many owners were subject to the alternative minimum tax and lost the benefit.
To assist startup entities, the credit can be applied to an employer’s portion of FICA – Federal Insurance Contributions Act – payroll taxes, up to $250,000 per year.
Specific to the payroll tax credit, a qualifying small business must have less than $5 million in gross receipts in the taxable credit year and no gross receipts for any tax year that precedes the fifth tax year before the year of the claim.
For example, taxpayers claiming a credit on their 2017 tax returns must have less than $5 million in gross receipts during 2017 and could not have had any gross receipts prior to 2013.
A business or taxpayer may qualify for Pennsylvania’s R&D tax credit if it meets the qualifications for the federal credit and the R&D is conducted in Pennsylvania.
Applications for the R&D credit must be submitted to Pennsylvania by Sept. 15 of the following year.
The tax credit can be applied to multiple taxes levied by Pennsylvania, including capital stock tax/corporate net income tax and personal income taxes for individuals who are a part of a pass-through entity.
The credit can only be used toward the tax liability connected to the part of the business that is approved for the credit.
If R&D credits exceed tax liability, there are two options: a business can choose to carry over the tax credit up to 15 years or it can sell the extra tax credits to a different company, potentially for up to 95 cents on the dollar.
Loretta Tubiello-Harr, Certified Public Accountant, is the principal/owner of Tubiello-Harr & Associates LLC in Coopersburg. Her firm concentrates in consulting and tax services and CFO advisory services for closely held businesses. She can be reached at email@example.com.