Every taxpayer yearns for a reduction on their tax bill. One of the biggest ways to achieve this is through tax credits, which lower the amount of tax liability owed. The federal research and development credit is obtained by businesses who enhance or develop their products or services, in an array of science related industries by tracking qualified research expenses. In 2015 the Protecting Americans from Tax Hikes Act passed, making this credit more beneficial to businesses of all sizes. There are two different calculations that can be used to compute the research and development credit. While the process may be tedious to track expenses, it can be very rewarding to taxpayers willing to invest their time calculating it.

The first major effect the PATH Act had on the research tax credit was making it permanent. Furthermore, this act now permits eligible small businesses to claim the research and development credit against their alternative minimum tax liability, which has in the past kept businesses from using the credit. The term eligible small business refers to a non-publicly traded corporation, a partnership, or a sole proprietorship that has gross receipts of less than $50 million for the previous three tax years. Another new provision of the Act allows startup businesses with no federal tax liability and gross receipts below $5 million to apply up to $250,000 of their research and development credit against their payroll taxes.

There are two different methods to calculate the federal research and development credit; the regular calculation and the alternative simplified research credit. Both of these calculations include detailed, multiple step processes. The regular research credit is calculated by first determining your base amount, which is a percentage of the average yearly gross receipts for the four previous tax years. This amount cannot be below 50% of the current year qualified research expenses. Next, the credit is calculated by using the sum of 20% of the excess of the research expenses for the tax year divided by the base amount, plus 20% of the basic research payments (plus 20% of the business’s expenditures on qualified energy research, if applicable). The alternative simplified research credit, on the other hand, is equal to 14% of the excess of the qualified research expenses for the tax year, divided by 50% of the average qualified research expenses for the three preceding tax years. However, if the business had zero qualified research expenses over the past three years, the credit is 6% of the current year research expenses.

The hurdles associated with obtaining a research and development credit cause many taxpayers to shy away from trying to claim it. An issue with the regular credit is that it is more difficult for some businesses to utilize due to inconsistent annual qualified research expenses altering the base amount, resulting in large tax breaks for some businesses, while rendering the credit unusable for other businesses. Some businesses simply choose the alternative simplified research credit because it is easier to calculate, and usually gives their business some credit, albeit generally smaller. Most businesses do not realize that the process is not as challenging as it is believed to be to claim the credit. The most demanding aspect is making sure proper tracking procedures are in place to document the annual research and development activities. It is recommended that businesses seek assistance from a tax professional that specializes in the research and development credit. An expert will not only guide you through the process, but also give qualified advice to assure you it is being completed efficiently and effectively.

The Protecting Americans from Tax Hikes Act of 2015 has ensured the federal research and development credit is here to stay, and will create many opportunities for businesses. With the assistance of a tax professional to track qualified research expenses, and choose the correct calculation, the research and development credit could give you that tax reduction you have been hoping for. Although the research credit is not appropriate for everyone, any businesses that are eligible to receive the credit should take advantage. As always, please contact your Dermody, Burke, and Brown advisor if you have any questions.

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.