Permanent extension and expansion of research and development tax credit

The research and development (R&D) credit provides an incentive for companies to invest in innovation in the US. The R&D credit is available to companies in any industry that develop new products or processes or improve upon existing products or processes. Companies that qualify can claim wages, supplies, and contract research costs associated with R&D projects and activities.

On Dec. 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (PATH) Act of 2015, which included the following important changes to the R&D credit.

• Made permanent the R&D credit
• Allows businesses with less than $50 million in gross receipts to offset the R&D credit against alternative minimum tax (AMT)
• Allows certain small businesses with less than $5 million in gross receipts to offset the R&D credit against payroll taxes

These changes positively affect businesses of all sizes that invest in R&D projects and activities in the US.

Permanent R&D credit

Congress originally enacted the R&D credit in 1981 as a temporary credit that was set to expire in 1985. Since 1985, the R&D credit was extended 15 times, often at the end of the calendar year, or retroactively in the following calendar year, with a one- or two-year extension. This uncertainty limited the overall effectiveness of the R&D credit by making it difficult for businesses to consider the credit in strategic planning for R&D investments.

The PATH Act eliminates the uncertainty surrounding the availability of the R&D credit by making it permanent. With a permanent R&D credit, taxpayers can more effectively plan and commit to long-term investments in R&D and innovation.

Offset against AMT

Under prior law, taxpayers in AMT received no immediate benefit from the R&D credit since it could not be used to offset AMT. However, for tax years beginning after Dec. 31, 2015, “eligible small businesses” (ESBs) will be able to claim the R&D credit against its AMT liability. The ability to offset the credit against AMT removes a major obstacle associated with utilization of R&D credits, particularly for owners or members of pass-through entities.

An ESB is a sole proprietorship, partnership, or non-publicly traded corporation with average annual gross receipts for the prior three taxable years that do not exceed $50 million. Partners of a partnership and shareholders of an S corporation must separately meet the gross receipts requirement to use the R&D credit against their individual AMT liability.