R&D Tax Credit Changes to 2016 Tax Returns May Benefit Small Businesses

The tax code provides a research and development (R&D) tax credit to spur invention and innovation in the United States.  However, the structure of the R&D credit rendered it useless to many small businesses that did not have regular income tax liability.  New tax law enacted at the end of 2015 made three significant changes to the R&D credit allowing the credit to benefit many more small businesses.

1.      The R&D tax credit was made a permanent feature of the tax code (no more waiting for Congress to extend the credit every one to two years), being retroactively extended to qualifying research expenses paid or incurred after 2014.

2.      For tax years beginning after 2015, eligible small businesses (ESBs) having $50 million or less in gross receipts may claim the R&D credit against their alternative minimum tax (AMT) liability (previously the credit could not reduce AMT).

a.      An ESB is defined as a sole proprietorship, partnership (including an LLC), or non-publicly traded corporation having average annual gross receipts for the three prior tax years of $50 million or less.

                                                              i.      Partners (including LLC members) and S corporation shareholders must also separately meet the gross receipts test since the credit is claimed against their individual income tax liability.

b.     It appears that an unused ESB 2016 R&D tax credit may be carried back one taxable year and be claimed against 2015 AMT for a refund.

3.      For tax years beginning after 2015, qualified small (start-up) businesses (QSB) having less than $5 million of gross receipts for the current year may elect (by the due date of the tax return including extensions) to claim up to $250,000 per year of the R&D credit against their employer FICA tax liability.  The election is made by completing new Section D on revised Form 6765 (Credit for Increasing Research Activities).  New Form 8974 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities) will be filed with a revised Form 941 (Employers Federal Quarterly Tax Return) to claim the elected R&D credit against the employer’s FICA tax liability on line 11 of revised Form 941.

a.      A QSB is defined as a sole proprietorship, partnership (including an LLC), or a corporation having gross receipts for the tax year of the election of less than $5 million

b.     A QSB must not have had any gross receipts for any tax year preceding the five-taxable-year period ending with the current tax year.

                                                              i.      For the 2016 tax year, any gross receipts in 2011 or earlier disqualifies the business.

c.      The election may only be claimed for five taxable years.

d.     The credit can only offset the employer’s FICA tax liability for the first calendar quarter beginning after the date on which the QSB files its income tax return claiming the R&D credit and making the election.

                                                              i.      For example, if a C corporation files its 2016 calendar year income tax return on April 15, 2017, the earliest payroll tax savings will be for the third calendar quarter payroll tax return beginning July 1, 2017 and ending September 30, 2017.  If the tax return is filed by March 15, 2017, then the credit be claimed against the second quarter payroll tax return.

e.      If the elected credit exceeds the quarter’s employer FICA liability, the excess credit carries over to the next quarterly payroll tax return.

f.       Special rules apply to determine who makes the election and for determining gross receipts of controlled groups of businesses.