This Insights was contributed by Caroline Ballance, CPA (NC License Number 39017), an associate at Adam Shay CPA, PLLC.

With the onset of the New Year, we have new and exciting changes for tax credits related to research and development, referred to as the R&D Tax Credit. When President Obama signed the PATH Act into law, there were some changes to the R&D Tax Credit that became effective Jan. 1, 2016.

In the past, an eligible company with qualified research expenditures could use those expenses as a credit to offset income tax. There was no limit on the amount of the credit, or industry, and it could be carried forward 20 years.

Under the new PATH Act, there are three major changes:

1. The credit is permanently extended.
2. The credit can offset payroll tax for qualified small businesses.
3. The credit can be used to offset Alternative Minimum Tax (AMT), for certain eligible entities.

To use the credit as an offset against payroll tax, you need to make an election with your income tax return. As an example, if the company had payroll in 2016, an election would be made with the 2016 income tax return filed in 2017. Then, the credit would be used to offset payroll taxes moving forward (i.e. first quarter of 2017, and so on) until used up. 

So, the sooner the tax return is filed, the sooner you can capitalize on the credit. The maximum credit allowed is $250,000 per each eligible year, and the credit can be claimed for five years. Also, the credit can only be used to offset social security tax.

The payroll tax offset can be used in companies that:

• Have gross receipts for five years or less. Therefore, for the 2016 tax year, the company is ineligible if it had gross receipts prior to 2012.
• Have less than $5 million in gross receipts in 2016 and each subsequent year the credit is elected.
• Have qualifying research activities and expenditures.

You are probably wondering what type of expenses are considered qualified research expenditures. Eligible expenses can include wages, supplies, contract research and computer leasing, to name a few.

A company is eligible to deduct 65 percent of payments made to contractors for research expenses. Companies claiming the credit, whether against payroll taxes or income taxes, will need to make sure to allocate payroll between R&D activities and any other activity, as only the R&D activity is eligible. It is crucial to have a way to identify expenses for R&D. 
 
Once you have determined the qualified research expenditures - salaries and wages, 65 percent of contractor expense, supplies and any other miscellaneous expenses - you will need to calculate the credit you are allowed to take.
 
To do this, you first total all qualified expenses.  You then determine the base amount, which is the greater of 50 percent of the qualified research expenditures or three percent of your average gross revenue for the last four years. Once you determine the base, you multiply that figure by 20 percent. This will yield you the maximum allowed credit for the current year. 
 
There is also an alternative simplified credit calculation. For this calculation, you determine the base amount by taking the average of your total qualified research expenditures for the last three years and then multiply by 50 percent. You then take the base times 14 percent to yield the maximum credit allowed.
 
If a company does not have payroll or if they are not a qualified small business, they can still use the credit to offset income tax.
 
The changes to the R&D tax credit could really help a lot of businesses that otherwise, under the old rules, would not be eligible for a credit because they do not have taxable income. A lot of times, startup companies and companies in the R&D phase are not generating a profit and therefore do not have taxable income. 
 
However, these companies do typically have payroll, so they will be able to receive immediate benefit from this credit under the new PATH Act changes.
 
If you think your company may be eligible for this credit, or would like our assistance in determining if you can, please reach out to our office.
 
Caroline Ballance, CPA (NC License Number 39017), is an associate at Adam Shay CPA, PLLC. She has a keen interest in working with dental practices to help grow their business.  For more information, visit http://www.wilmingtontaxesandaccounting.com/ or email her at [email protected].