The U.S. Research and Experimentation Tax Credit, more commonly known as simply the R&D Tax Credit, is a refundable federal tax credit that was introduced as a way to incentivize business investment in U.S.-based research and development, particularly in manufacturing. The aim is to improve American-made products with innovative
technology and processes, and to reward companies that commit to continual improvements. The first incarnation of the R&D tax credit, however, was only enacted as a temporary provision, designed to give a quick boost to the waning manufacturing sector. Although lawmakers voted to renew it each year, this impermanence made many companies wary of allocating funds into costly R&D for fear that they would not be reimbursed. The credit was also of little use to startups and small businesses that were often impeded by the alternative minimum tax (AMT) thresholds and income tax limitations.
Congress passed the Protecting Americans from Tax Hikes (PATH) Act in December 2015 which, among other statutes, made the federal R&D tax credit permanent. It also eliminated some of the most significant barriers to small manufacturers and fledgling companies. This business tax credit is one of the largest available, and now even more businesses will be able to take advantage of its revenue-boosting benefits.
Tax savings are a boon to any company, but the impact is even greater on new and small manufacturers that are often running under thin margins. Paying less in taxes or receiving an increased refund can allow a company to reinvest capital into the business, expanding its reach. In addition, these funds can now become a fixed aspect of a company’s financial and tax planning, and can count on it to subsidize the costs of improving its products and enhancing its operations. However, there are two additional changes that are central to the challenges faced by small and developing manufacturers:
AMT Limit Eliminated
Most small and medium manufacturing companies are subject to the AMT which, until recently, prevented companies from claiming the R&D credit beyond that amount. This left a lot of money on the table. Even if companies otherwise qualified for the credit, their savings were significantly reduced by the presence of the AMT, which imposes a mandatory tax payment even if federal income tax is reduced to zero via deductions and credits. As a result, the credit is all but useless to many businesses.
The Small Business Jobs Act temporarily turned off the AMT requirement with regard to the R&D credit in 2010, and the PATH Act made the rule permanent in 2015. To be eligible under the new statutes, the business must be a sole proprietorship, partnership or privately held corporation that averaged less than $50 million in gross annual receipts in the three previous years.
Before the PATH act, startups also found it difficult to take advantage of the R&D tax credit. Challenges arose for a large portion of newcomers to the manufacturing field, as most of these businesses don’t turn a profit for the first few years and usually don’t pay federal income tax. The consequence of that low tax bill was an inability to apply the credit, excluding the newest, most innovative businesses from the tax breaks that were essentially created for them. Worse, it excluded a growth-promoting tool precisely when that kind of help is most needed -- before profits start rolling in. But the real rub is that even though these companies often pay little to no income taxes, they are still responsible for the employer portion of payroll taxes, leaving little money for improvements or expansion.
After the PATH act was passed, eligible startups in the manufacturing, and other industries, gained the ability to receive a refundable credit for up to $250,000 of their employer-side payroll taxes each year for up to five years. Qualified startups include general and S corporations, partnerships and sole proprietorship with gross receipts below $5 million.
These changes have made it easier for a larger number of small- to medium-sized manufacturers to leverage the R&D credit. Companies in all industries are eligible, including software, pharmaceuticals, health sciences, food and agriculture, robotics and nanotechnology, energy, architecture, construction, metals and plastics, chemicals, vehicles and many others. It covers:
- Costs that are incurred to develop new products and processes or improve on existing ones.
- Expenses related to implementing innovative, streamlined operational systems such as automated processes.
- Ensuring the reliability and quality of each part created from the assembly line they developed.
- Expenditures from designing, building and testing prototypes, including three-dimensional modeling costs.
- Spending to comply with emissions and other environmental protection regulations.
The tax credit can finally work as intended, supporting creative problem-solving and rewarding development that makes the creation of products more efficient, cost-effective and environmentally friendly.
The R&D tax credit translates into immediate savings for small manufacturers, facilitating growth throughout every business sector and stimulating domestic job creation. It also encourages the emergence of forward-thinking new businesses with groundbreaking ideas that funding issues would otherwise block from ever seeing the light of day. Decision-makers in manufacturing organizations need to consider the benefits of the new research and development tax credit laws, and reexamine their company’s eligibility for this powerful financial resource.
The professionals at GPP have vast experience in advising their manufacturing clients on not only R&D tax credits, but other tax credits and incentives available to that industry. Contact GPP for further information.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.