The PATH Act permanently extended the R&D tax credit and made two very important changes effective December 31, 2015. In years past the credit was retroactively extended on a regular basis.
The legislation allows small businesses to take the R&D tax credit against their alternative minimum tax (AMT) liability for tax years beginning after December 31, 2015. The AMT restriction has long prevented qualified companies from utilizing the R&D tax credit; the legislation removed that hurdle for eligible small businesses (“ESB”). An ESB is defined as a corporation that is not publicly traded, a partnership, or a sole proprietorship with average annual gross receipts not exceeding $50 million for the three taxable years preceding the current taxable year. For a partnership or S corporation, the gross receipts test must be met both by the entity and by the partner or shareholder for the tax year.
The PATH Act also allowed for startup businesses with gross receipts of less than $5 million in the claim year, and no gross receipts for any tax year before the five year period ending with the claim year, to take the R&D tax credit against their FICA payroll taxes for tax years beginning after December 31, 2015, essentially making it a refundable credit capped at $250,000 for up to five years (must be on original return, extensions included). Note that in March of 2017, Treasury released Notice 2017-23 which provides interim guidance related to the payroll tax credit. Under the Notice, gross receipts are defined as total sales (net of returns and allowances), receipts for services, and investment income (interest, dividends, royalties, etc.). This is important since, as written, a taxpayer with even minimal gross receipts from bank interest or other investment income in any year prior to the five-year period previously mentioned would be precluded from electing the payroll tax credit.
As a result of the Tax Cuts and Jobs Act (“TCJA”) in 2018, the corporate AMT was repealed. With the repeal, non-ESB businesses that were limited by AMT can now offset regular tax with the R&D credit. However, taxpayers with an income tax liability of more than $25,000 will still be subject to the 25/25 limitation— i.e. taxpayers can offset the first $25,000 of tax, plus up to 75% of the tax in excess of $25,000—so they won’t be able to reduce their tax liability all the way down to zero. For example, a taxpayer with $100,000 of federal tax liability for the tax year can offset up to $81,250 of tax ($25,000 + (75% x ($100,000 - $25,000)).