Public Law no. 115-97, “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (“the Act”) was signed into law by President Trump on December 22, 2017. As the largest tax reform package to be passed by Congress in the last 30 years, the Act impacts many areas of tax law in both a direct and indirect manner. The Credit for Increasing Research Activities (“Research Credit”), codified under IRC Section 41, was not left out of the Act’s broad reform impact. Provisions of the Act will further enhance the value and utilization of the R&D Credit in the future, increasing its importance to taxpayers.
OVERVIEW
As had been identified early in the tax reform process, the Research Credit would be preserved in its present form. The Act did not modify IRC Section 41, thereby retaining the favorable changes made by the PATH Act of 2015 which gave permanency of the credit, an Alternative Minimum Tax (AMT) offset for small businesses, and a payroll tax offset provision for start-up companies. However, changes made to other areas of the tax law will impact the credit in several favorable ways.
ENHANCEMENT
Reduced Corporate Tax Rate
Due to the decrease in the corporate tax rate, taxpayers will receive a greater net benefit from the Research Credit.
Pursuant to IRC Section 280C(c), the tax deduction for research expenses claimed for the Research Credit must be reduced by the amount of the Research Credit claimed. This prevents a double benefit being received by a taxpayer for the same research expenses. As an alternative to actually reducing deductions, a taxpayer may utilize a reduced credit rate, based on the maximum corporate tax rate.
With the Act reducing the maximum corporate rate from 35% to 21%, taxpayers will actually see an increase to the reduced credit rate creating an increase to the amount of credit earned. For those taxpayers not electing the reduced credit, there will still be a greater benefit received. This is so, because the credit remains a dollar-for-dollar tax offset, while the related deduction (which is lost) will now be offsetting tax liabilities at a lower rate.
EXPANDED UTILIZATION
Alternative Minimum Tax Changes
The Act provides for a repeal of the corporate AMT, effective for tax years ending after December 31, 2017 (Background sound of champagne corks popping!). As historically the Research Credit could not be used to offset AMT (Note: Starting in 2016, eligible small businesses can utilize the Research Credit against AMT), this will create an immediate increase in utilization of the credit for many corporations.
In addition, the AMT exemption amounts for individual taxpayers have been increased, which may reduce the applicability of the AMT in some cases, thus increasing the ability to utilize Research Credits. The AMT exemption amounts are scheduled to increase to $70,300 for single filers and $109,400 for joint filers; with a phase out for those taxpayers at $500,000 and $1 million, respectively. Please note: these increases are effective only through 2025.
Net Operating Loss (“NOL”) Limitations Added
Pursuant to the Act, effective for tax years ending after December 31, 2017, a taxpayer is limited in the amount of NOLs it can use to offset taxable income. This limitation, which is now 80% of taxable income, will result in some amount of tax liability due by a taxpayer. Thus, taxpayers that have not claimed the Research Credit because they were in a NOL position, should now consider this credit to offset future tax liabilities.
Additional tax law changes that will likely drive R&D activity or interest in the credit
100% Deduction of Capital Assets
Under the new reform Act, the 100% deduction of capital assets will only be available throughout 2022. Beginning Jan. 1, 2023, a phase down of this provision begins and capital assets will go back to being depreciated over 5 years. Due to this change, many businesses will find themselves accelerating major equipment acquisitions in the next few years.
While capital assets by themselves are not includible for the credit, purchases such of those in the area or robotics, R&D lab equipment and test machinery could spear new product and product research and development. In fact, there is often significant time needed from employees to get this type of equipment commissioned and integrated into existing processes, and this type of activity may qualify for the credit.
Capitalization of Research Expenses
While many companies today choose to offshore their R&D efforts, these costs have never been includible within the IRC Sec. 41 Research Credit.
Now under the new reform, effective for tax years beginning after December 31, 2021, the amortization of offshore cost will move from a 5 to 15 year treatment providing even less incentive for businesses to take their efforts overseas.
The inability to claim the research credit on offshore costs, along with the new amortization treatment requirement will certainly have U.S. based companies reevaluating the value of offshoring.
For some, the favorable tax impact of the Research Credit along with the ability to amortize onshore costs at 5 years should keep more research efforts here at home, and hopefully bring other efforts back on U.S. soil. (At the heart of it all, that’s what the R&D credit is all about.)
Elimination or Reduction in Value of other Credits and Incentives
Under the new tax reform act, many common credits and incentives that businesses have grown to rely on have been eliminated, and or for certain industries or types of entities, the value of these incentives have been significantly reduced. This is especially true for manufacturers who have previously turned toward the Domestic Production Deduction, IC-DISC and Like-Kind Exchange incentives as tax planning strategies.
If you’re a manufacture who has relied upon these valuable tax planning strategies in the past, now may be a time to consider the Research Credit to replace their diminished value.
While there are certainly limitations on the type of activity that qualifies for the research credit, most manufacturers involved with the development of new or improved products or processes will find themselves with an opportunity for eligibility.
To learn more about the impact of the new tax reform act on the research credit, you can join us on Thursday January 25 at 10:00 a.m. for a complimentary 30 minute webinar overview session.
