Business owners are almost hardwired to think about tax deductions all year long, and while they are an important mechanism to reduce your taxable income, tax credits are the big winner as they reduce your tax bill dollar for dollar.
While a deduction or exemption still reduces the final taxable income liability, they only do so within an individual’s marginal tax rate. So if you fall into the 21% tax bracket, a $1,000 deduction saves you $210. However, a tax credit valued at $1,000, for instance, lowers your tax bill by the corresponding $1,000. *Raises hands to pay nothing versus $790*
Thus, the R&D Tax Credit is not a deduction; it is an actual dollar-for-dollar credit against taxes owed or taxes paid. Additionally, the taxpayer may be able to expense all such qualifying R&D costs in the year incurred.
What’s more, a business can take the credit for all open tax years, generally, the last three or four years plus the current year and there can be refund opportunities in which the IRS will issue you a check for cash. Additional years may be available if the taxpayer is in a net operating loss or alternative minimum tax position. The best part is if you don’t use them you don’t “lose ’em” -credits can carry forward for 20 years, so have widely become a strategic tax planning tool amongst growing companies and their accountants.
The most popular benefit the last couple of years has been for Startups (ESBs). Eligible small businesses less than 5 years old with less than $5m in gross receipts in the current taxable year, can use R&D credits as a dollar for dollar offset against employer Payroll taxes (Social Security portion) up to $250,000 annually regardless of profitability.
For profitable businesses, there is no cap to how many dollars a company can claim (as its based upon their activities and correlated expenses each year), however, a company has excess they will not get a check if there are credits left over after reducing their tax bill to zero. Those credits will be simply banked for future use.
If I’m already deducting certain expenses, am I double-dipping?
The IRS permits businesses to deduct all R&D expenses in a single year instead of amortizing as a capital expense. You can choose whichever deduction method you want. However, you must generally decide to deduct R&D expenditures as a regular expense in the first year you incur expenses. For tax years beginning before Jan. 1, 2022, Sec. 280C(c)(1) provides that no deduction is allowed for that portion of qualified research expenses otherwise allowable as a deduction for the tax year that is equal to the amount of the credit determined under Sec. 41(a). However, taxpayers may elect to claim a reduced credit under Sec. 280C(c)(3), which eliminates the need for taxpayers to make such a modification to taxable income.
Tax law changes indirectly enhancing the R&D tax credit
The modification of the corporate tax rate recently increased the value of the R&D tax credit that corporate and non-corporate taxpayers may claim when electing to claim a reduced credit.
Before the TCJA, taxpayers had to reduce the amount of the credit by the maximum tax rate under former Sec. 11(b)(1), which was 35%. As a result, taxpayers claiming the reduced credit only recognized a tax credit benefit that equated to 65% of the credit determined under Sec. 41(a). Following the TCJA, taxpayers must reduce claimed credits by only 21%, as provided under amended Sec. 11(b), and thus will recognize a benefit that equates to 79% of the credit determined under Sec. 41(a). …long story short, a company with a $100,000 credit will receive a $79K benefit instead of $65k.