Congress has permanently extended the research and development (R&D) tax credit, retroactively as of January 1, 2015. This extension is part of the PATH Act of 2015.

Adding to the research credit’s much-anticipated permanence, the legislation also features important changes expanding how the R&D tax credit benefits are currently used, especially by small businesses.

The following are key enhancements as a result of the new R&D legislation changes:

On January 20, 2015, the IRS published proposed regulations (REG-153656-03) providing the revised internal-use software rules. Some of the key provisions and definitions include:

• Internal-Use Software: Software developed by the taxpayer for use in “general and administrative functions” that facilitate or support the taxpayer’s trade or business (e.g. financial management, HR, support services functions)
  
  
• Non Internal-Use Software: Software developed primarily for sale, lease or license to third parties
  
  
• Dual-Function Software: Internal-use software that has a subset of elements that interact with third parties
  
  
• Safe Harbor: If you cannot isolate a third-party subset, the rules allow for 25% of QREs to only meet the less stringent four-part test, while the other 75% would have to meet the seven-part test

Section 121(a) – Permanent Research Credit

This provision permanently extends the research credit (retroactively back to January 1, 2015). Taxpayers no longer have to deal with the regular expirations and the suspense of renewals. The credit is now permanent.

Opportunity: It should be noted that the change retroactively applies to costs paid by a cash method taxpayer or incurred by an accrual method taxpayer after December 31, 2014. Taxpayers who filed returns including part of calendar year 2015 may consider filing a refund claim as a result of applying the research credit to amounts paid or incurred after December 31, 2014.

Section 121(b) – Credit Allowed Against Alternative Minimum Tax (AMT) In Case Of An Eligible Small Business

This provision allows an eligible small business (ESB) that satisfies the less than $50 million gross receipts requirement to offset a taxpayer’s regular and AMT liabilities for tax years beginning after December 31, 2015.

An ESB with respect to any tax year can claim one of the following attributes:

• It’s a corporation of which the stock is not publicly traded
  
  
• The average annual gross receipts of the corporation, partnership or sole proprietorship for the three tax years preceding the tax year does not exceed $50 million

Opportunity: Taxpayers that previously could not receive the credit due to limitations related to AMT can now receive R&D tax credit benefits.  

Section 121(c) – Treatment Of Research Credit For Certain Start-Up Companies

This provision allows a qualified small business (QSB) to claim the R&D tax credit against its payroll taxes up to $250,000.

To apply the research credit against payroll taxes an election must be made on a timely filed return including extensions, at the entity level in the case of a partnership or S corporation. These research credits may be claimed for taxable years after December 31, 2015.

A QSB, for purposes of this section, is a corporation or partnership that is not a tax-exempt company under Code Section 501, has gross receipts of less than $5 million and did not have any gross receipts prior to the five-tax-year-period ending with the tax year.

Opportunity: Taxpayers who are in an income tax loss position may still be able to use the research credit against payroll taxes.

Ready to learn if your business activities qualify for the R&D tax credit? Download your complimentary, educational guide below.