Many of the changes brought about by the Tax Cuts and Jobs Act (TCJA) can benefit taxpayers already claiming the credit for increasing research activities (as well as those who may have overlooked it in the past). However, taxpayers should also be aware of the law’s delayed impact on the treatment of R&D expenditures and related credits for later tax years.
Several aspects of the TCJA have made R&D credits more attractive to the companies that use them.
Lower Corporate Tax Rate
Pre-TCJA, taxpayers were required to reduce their deduction for R&D expenses by the amount of the R&D credit. This prevented taxpayers from recognizing a double tax benefit. Alternately, taxpayers could take a reduced R&D credit instead of reducing their deduction for R&D expenses. If elected, the R&D credit was reduced by the tax savings created by the double tax benefit, which was calculated using the maximum corporate tax rate of 35%.
The decrease in the corporate tax rate by the TCJA has increased the value of the R&D credit for taxpayers that elect to claim a reduced R&D credit. With the maximum rate now at 21% instead of 35%, the reduced credit now equals 79% instead of 65% of the credit.
Limitation on the Use of NOLs
For tax years beginning after December 31, 2017, the TCJA restricts the use of net operating losses (NOLs) to the lesser of the aggregate of these losses carried to the current tax year, or 80% of taxable income. (Before the new law, taxpayers were able to offset 100% of their taxable income this way.)
As a result, some taxpayers that previously used NOLs to reduce their tax liability are using the R&D credit to help make up the difference. Prior to the TCJA, a taxpayer could offset 100% of their income with net operating losses that they generated in other years.
The new law now says that any NOLs that you generated in years beginning before December 31, 2017, can still offset 100% of your future income. However, you can’t use any NOLs that you generate in a year beginning after that date to eliminate 100% of future income.
For example, a corporation has a loss of $200,000 in the tax year ending December 31, 2018. In 2019, it has $100,000 of taxable income. The corporation can only use $80,000 of the $200,000 NOL generated in 2018 because it’s limited by 80% of the current year income. So that would leave them with $20,000 of taxable income.
This is a good opportunity for the taxpayer to try to utilize the R&D credit to reduce the remaining taxable income. (Note that this NOL limitation is only effective for losses generated in tax years beginning after December 31, 2017, and does not apply to losses generated in years beginning before this date.)
Elimination of Corporate AMT
Pre-TCJA, certain corporate taxpayers were subject to alternative minimum tax (AMT). This prevented some taxpayers from using R&D credits due to the tentative minimum tax limitation.
The TCJA eliminated AMT for corporate taxpayers, therefore allowing more companies to take advantage of the R&D credit. However, taxpayers with a regular tax liability of over $25,000 cannot use the credit to reduce that amount by more than 75%.
Impact on R&D Expenses for Tax Years Beginning After Dec 31, 2021
While these changes may increase the benefit for taxpayers claiming the R&D credit, it is important to also understand future changes to the treatment of R&D expenses.
Before the TCJA took effect, taxpayers could choose to deduct R&D expenses or capitalize and amortize these expenses. Now, however, taxpayers are required to capitalize and amortize R&D expenses incurred in the U.S. over five years. (Expenses incurred outside of the U.S. will be amortized over 15 years.)
Research and development efforts are an important part of a company’s growth, contributing to the creation and improvement of products and services. And thanks to the Tax Cuts and Jobs Act, your company can also get a tax benefit by taking further advantage of R&D credits. Your manufacturing and technology CPAs can show you the best way to leverage these credits and improve your bottom line.
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