What types of expenses qualify for the Research Credit?
Qualified research expenses (QREs) eligible for the research expense credit are amounts the taxpayer, or a startup company, pays or incurs during the tax year for in-house and contract research expenses while carrying on a trade or business. QREs have to be eligible for treatment as research and experimental expenses, undertaken to discover information that is technological in nature, intended to develop a new or improved business component, and elements in a process of experimentation. Expenses do not qualify as QREs if they are for research conducted outside the U.S.; research in the social sciences, arts, or humanities; and research to the extent funded by any grant, contract, or otherwise by another person.
Previously, corporations subject to alternative minimum tax (AMT) couldn’t offset the research credit against their AMT liability, which erased the benefits of the credit (although they could carry unused research credits forward for up to 20 years and use them in non-AMT years). By eliminating corporate AMT for tax years beginning after 2017, the TCJA removed this obstacle.
Now that the corporate AMT is gone, unused research credits from prior tax years can be offset against a corporation’s regular tax liability and may even generate a refund (subject to certain restrictions). Therefore, it is a good idea for corporations to review their research activities in recent years and amend prior returns if necessary to ensure the corporation claims all the research credits that they are entitled to.
The TCJA didn’t eliminate individual AMT, but it did increase individuals’ exemption amounts and exemption phaseout thresholds. As a result, fewer owners of sole proprietorships and pass-through businesses are subject to AMT, allowing more of them to reap the benefits of the research credit as well.
More to consider
By reducing corporate and individual tax rates, the TCJA will also increase research credits for many businesses. Why? Because a portion of the tax code that prevents double tax benefits requires businesses to reduce their deductible research expenses by the amount of the credit.
To avoid this result (which increases taxable income), businesses can elect to eliminate the double benefit by reducing the credit by an amount calculated at the highest corporate rate. The highest corporate rate has been reduced from 35% to 21% with the TCJA, so with this election, a higher percentage of the research credit remains.
Keep in mind that the TCJA didn’t affect certain research credit benefits for smaller businesses. Pass-through businesses can still claim research credits against AMT if their average gross receipts are $50 million or less. Qualifying start-ups without taxable income can also still claim research credits against a maximum of $250,000 in payroll taxes.
Do your research
If your company engages in qualified research activities, now is a good time to revisit the credit to be sure you’re taking full advantage of its benefits.