Impact of the Tax Cuts and Jobs Act on R&D Tax Credits
The largest and most complex tax cut in U.S. history, the Tax Cuts and Jobs Act (TCJA), has left American business owners wondering how the changes to the tax code will affect them and their businesses. In the coming months, business executives and their tax preparers will be scurrying to reformulate their tax strategies and business plans ahead of year’s end. Perhaps the best news for owners of manufacturing and technology-based companies is that the TCJA retains the R&D Tax Credit in its current form, though several features of the TCJA could have a profound impact on companies that claim research credits and their ability to deduct research expenditures in coming years.
Reduction of the Corporate Tax Rate
While it’s debatable that the TCJA will simplify tax filing for the majority of Americans, it’s clear that the big winners are the C-corporations who will enjoy a significantly reduced maximum tax rate of 21%, down from 35%. Manufacturing and technology-based companies will also reap a greater reward from the R&D Tax Credit. Under current statute, taxpayers are required to reduce their R&D expenses by the amount of the credit, which consequently increases taxable income before deducting the credit from the tax owed. The lower corporate tax rate will subsequently increase the cash benefit from about 65% of the credit amount to about 79%. In other words, an R&D tax credit of $100,000, which would have provided a $65,000 cash benefit, will in the future provide a net cash benefit of about $79,000.
Elimination of Corporate Alternative Minimum Tax
The elimination of alternative minimum tax (AMT) in the TCJA also benefits C-corporations. Prior to enactment of the tax revision legislation, corporations were required to pay tax at a minimum rate of 20% regardless of any credits or deductions. With the elimination of AMT, corporations will have the ability to further reduce their tax bills using R&D tax credits. Note that the TCJA retains the rule effectively known as the “25/25 limitation,” which restricts taxpayers with over $25,000 in regular tax liability from offsetting more than 75% of their tax liability using the credit.
Alternative Minimum Tax for Pass-Through Entities
For the owners of pass-through entities such as S-corporations, LLCs, and partnerships, the revisions to the tax code do not alter the existing provision relating to individual AMT limitations. The tax code will continue to permit the shareholders of enterprises having less than $50 million in average revenue over the prior three years to use the R&D credit to offset AMT. The owners of businesses or the combination of businesses having more than $50 million in revenue will not be permitted to reduce AMT on their personal returns.
Amortization of Research Expenditures Starting in Tax Year 2022
Business owners should be aware that the TCJA includes a host of provisions that are intended to safeguard Treasury revenue. One such provision requires companies to expense US-based research expenses to a capital account and deduct the expenditures over a five-year period beginning with tax year 2022. Expenses incurred for research performed outside of the United States will need to be charged to a capital account and deducted over a 15-year period. It should be noted, however, that we anticipate this provision will be eliminated in the coming years.
How We Can Help
If you have any questions on these topics or if you would like to discuss your company’s unique situation, contact Source Advisors for a free consultation.