In December 2017, President Donald Trump signed the Tax Cuts and Jobs Act into law. The law preserves and enhances the value of the Research and Development Tax Credit — to encourage companies to invest in developing or improving products and/or processes, exactly what it was created to do since its inception in 1981.
But Trump’s new law not only supports the tax credit, it enhances the value of R&D-qualified activities. Here’s how.
Lower Corporate Tax Rate
The law cuts the corporate tax rate from 35% to 21%. This cut, in effect, increases the research credit’s net benefit by more than 21% (from the previous amount of 65% to 79%). This 21% increase in the credit’s net value is due to IRC Section 280C(c).
Enacted to prevent taxpayers from getting a double benefit for their research-related expenses (a deduction and a credit for the same expenses), Section 280C(c) requires taxpayers to (1) reduce their deduction for IRC Section 174 allowable expenses by the amount of the Research Credit, or (2) elect a reduced credit generally equal to the research credit minus the product of the research credit and the maximum corporate tax rate.
With the maximum rate now at 21% versus 35%, the reduced credit now equals 79% instead of 65% of the research credit (100% less 21% versus 100% less 35%).
Corporate Alternative Minimum Tax Repealed
The law repeals the corporate Alternative Minimum Tax (AMT) provisions. Taxpayers who were previously subject to AMT and who typically wouldn’t have been able to use research credits to offset their federal income tax liability, will now be able to do so.
Historically, corporations could only use the the credit to offset ordinary income tax liability and not their AMT. Starting in 2016, the Protecting Americans from Tax Hikes Act (PATH Act) allowed eligible small businesses (privately held businesses with $50 million or less in average gross receipts for the three preceding tax years) to utilize the tax credit against their AMT.
By eliminating the AMT’s Tentative Minimum Tax for corporations, the law allows the research credit to reduce a taxpayer’s liability down to 25% of the amount of net regular tax liability that exceeds $25,000, a limitation imposed by IRC Section 38(c).
Modification of Net Operating Loss Deduction
The law limits the amount of Net Operating Losses (NOLs) that a taxpayer can use to offset taxable income to 80% of its taxable income for losses arising in tax years beginning after December 31, 2017. NOL taxpayers may now find the research credit a helpful way to offset the taxes they’ll have to pay.
The law also repeals the provision allowing for the current two-year carryback of NOLs and allows an indefinite carryforward of NOLs arising in tax years ending after December 31, 2017.
