The Credit for Increasing Research Activities, also referred to as the “R&E”, “R&D” or “Research” tax credit, incentivizes companies to invest in people and technology that can lead to growth in revenues and profitability, as well as promote job retention and expansion. The credit focuses on three types of qualifying expenditures: wages, supply costs and contract research.
The utility of the R&E tax credit varies between early stage companies, which can elect to offset payroll taxes with the credit; and more mature companies which use the credits to offset income taxes at the federal and often at the state level.
The tax code prevents taxpayers from taking both a credit and a full deduction from the qualifying expenditures that led to the credit. However, the taxpayer can elect a so-called reduced credit that, while a lesser amount, does not decrease the tax deduction from the expenses that generated the credit.
This election incorporates a decrease in deductions and associated additional taxes into the formula. It does this by reducing the credit by the highest corporate tax rate in the tax code. Until 2017, the highest corporate tax rate in the tax code was 35%, so this election reduced the credit by 35%.
For example, if a taxpayer makes this election and has $1,000,000 in qualifying expenses that generate a $100,000 research tax credit, the taxpayer can’t get both a $1,000,000 deduction and a $100,000 credit on the same expenditures. The taxpayer must reduce its research deductions of $1,000,000 by the $100,000 credit amount to $900,000. In this case, the net benefit of the credit is the $100,000 credit less the $35,000 (due to the loss of deduction of $100,000) in additional taxes or $65,000.
Starting in 2018, thanks to the 2017 Tax Cuts and Jobs Act, the maximum corporate tax rate has been reduced from 35% to 21%. Consequently, the 35% reduction of the credit by making the election has now been reduced to 21%. In the example above, in 2018 the taxpayer would receive a net benefit of $79,000. The net benefit would be increased by $14,000 (35% - 25% x $100,000), due to the reduction of the highest corporate tax rate from 35% to 21%.
As the current year draws to a close, innovative companies using the R&E tax credit may look forward to a bigger benefit than seen in previous years. If you have questions regarding these changes to the tax law or to discuss your eligibility, please contact one of RubinBrown’s Tax Services Group professionals.
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Research & Experimentation Tax Credit Services Overview