Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

Enhancement 1: Start-up companies are able to use the research credits generated in tax years beginning after December 31, 2015 against payroll tax

Q. What is the definition of a qualified small business (start-up company)?
A. A qualified small business is defined, with respect to any taxable year, as a corporation (including an S corporation) or partnership with gross receipts of less than $5 million for the taxable year and no more than 5 years of gross receipts history.

Q. What part of the payroll tax is refundable?
A. The employer OASDI liability of 6.2% is refundable. The credit does not apply against the employee portion.

Q. Is there a limit to the amount of payroll tax that can be offset with the credit?
A. The payroll tax credit is limited to $250,000 per year for no more than five years.

Q. Are members of the same controlled group treated as a single taxpayer?
A. Yes. The amount of the credit is allocated among the members in proportion to each member’s qualified research expenses. Each member may separately elect the payroll tax credit for its portion of the credit.

Q. How do you elect the payroll tax credit?
A. A taxpayer makes an annual election specifying the amount of its research credit that will be applied to its payroll tax, not to exceed the $250,000 limitation. The taxpayer will make the election on or before the due date of its originally filed return, including extensions. The election cannot be revoked without the consent of the Secretary of the Treasury. In the case of a partnership or S Corp, the election to apply the credit against OASDI liability is made at the entity level.

Q. How is the credit applied against OASDI tax liability?
A. The payroll tax is allowed as a credit in the first calendar quarter beginning after the date in which a taxpayer files its tax return for that taxable year. The credit may not exceed the tax liability for a calendar quarter. The excess is allowed as a credit against subsequent calendar quarters until the entire credit amount is used.

Enhancement 2: Small businesses are able to use the research credits generated in tax years beginning after December 31, 2015 against Alternative Minimum Tax

Q. Who can apply the research credit against AMT?
A. An eligible small business can apply the credit against AMT. An eligible small business is defined as either a non publicly-traded organization, a partnership or sole proprietorship whose average gross receipts for the prior three years is less than $50 million.

Q. Will prior year credits carried forward into 2016 be usable against AMT?
A. No. Prior year credits are still subject to the AMT limitation. However, any credits carried forward will be used before any current year credits. To the extent a taxpayer has regular tax due above minimum tax in 2016, the carryforward credit would be used first down to the minimum tax amount, and then the current year credit would be applied against minimum tax.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (PATH) Act of 2015, extending many of the business and individual tax provisions and finally making permanent the research and development (R&D) tax credit.

 

Start-ups and small businesses benefit from changes to R&D tax credit

In addition to making the credit permanent, the Act also contains two favorable changes for small businesses and start-ups beginning in 2016. These two noteworthy enhancements are:

  • The credit is now able to offset Alternative Minimum Tax (AMT) for eligible small businesses, companies with less than $50 million in gross receipts. For small business owners, the AMT limitation was the largest obstacle that kept companies from taking advantage of the research credit. For 2016 and forward this limitation is lifted.
  • Start-up companies, whether corporations or partnerships, can apply the credit to offset up to $250,000 in payroll taxes beginning in tax years after December 31, 2015. Start-ups are defined as businesses with less than $5 million in gross receipts in the current year and less than five years of historical gross receipts.

A permanent credit provides stability and certainty to all companies while the enhancements are game changers for small businesses.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

Start-ups and small businesses benefit from changes to R&D tax credit

The House today passed a permanent extension of the Research and Development (R&D) tax credit as part of the Protecting Americans from Tax Hikes Act of 2015. Finally companies can rely on the permanency of the credit, which will allow them to better plan for investments in research.  In addition to making the credit permanent, the Act also contains two favorable changes for small businesses and start-ups beginning in 2016.  These two noteworthy enhancements are:

  • The credit is now able to offset Alternative Minimum Tax (AMT) for eligible small businesses, companies with less than $50 million in gross receipts. For small business owners, the AMT limitation was the largest obstacle that kept companies from taking advantage of the research credit.  For 2016 and forward this limitation is lifted.
  • Start-up companies, whether corporations or partnerships, can apply the credit to offset up to $250,000 in payroll taxes beginning in tax years after December 31, 2015. Start-ups are defined as businesses with less than $5 million in gross receipts in the current year and less than five years of historical gross receipts.

A permanent credit provides stability and certainty to all companies while the enhancements are game changers for small businesses. The bill is now waiting for Senate approval after which the president is expected to sign it into law.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

A recent court case provides guidance on owner compensation and when it qualifies as a research expense under §174.  This qualification under §174 then dovetails with the §41 research and development (R&D) tax credit calculation and can have a huge impact.  Many companies are led by entrepreneurs who spend significant time developing or improving the company’s products and processes rather than managing day-to-day operations.  These qualifying activities can have a substantial impact on the size of a company’s credit.

In Eric G. Suder vs. Commissioner, Mr. Suder claimed that 75 percent of his time was devoted to research activities.  Mr. Suder was the creative genius behind the company’s products, spending most of his time guiding product development from idea generation through testing. As a result, the company grew from a one-man, garage-based startup to a thriving 125-person organization. Like many entrepreneurial CEOs, Mr. Suder spent very little time managing day-to-day operations. Instead, his time was spent contributing to senior product strategy and follow up product meetings, reviewing product specifications, and researching networking technology that could be incorporated into the company’s products.

However, the IRS disallowed Mr. Suder’s R&D credits and also challenged whether the compensation paid to Mr. Suder was reasonable under §174.  Mr. Suder argued that engineering’s role was to execute on his innovative ideas, and that his compensation was based on his creative contributions. Mr. Suder’s total compensation package during the period in question ranged from ~$8-11 million and was comprised of a base salary and bonuses, with bonuses based on growth, overall value and cash flow.

After a thorough analysis by the court, 75 percent of Mr. Suder’s salary was confirmed as qualified.   Mr. Suder was able to convince the court through documentation and oral testimony that he participated heavily in research. Mr. Suder provided credible documentation supporting his research efforts.

With respect to his compensation, according to the law, “Under §174(e) a taxpayer may deduct a research and development expenditure only to the extent that the amount thereof is reasonable under the circumstances.” The amount of an expenditure is considered reasonable if “the amount would ordinarily be paid for like activities by like enterprises under like circumstances.”  The court addressed the issue of “reasonable” with respect to how much of an owner’s compensation can be included in the credit computation.  The court evaluated eight factors including the employee’s qualifications, the nature, extent and scope of the employee’s work, the size and complexities of the business, and the prevailing rates of compensation for comparable positions in comparable concerns.

After evaluating these factors and hearing from expert witnesses for Mr. Suder and the IRS, both of whom compared Mr. Suder’s wages to those of other CEOs performing similar services in similar companies, the court determined that while they agree with Mr. Suder’s high compensation as a CEO, the amounts were unreasonable under §174.  The court determined that reasonable wages under §174 would be $2.3-2.6 million. These wage amounts represented base salary, annual incentive and long-term incentive.  The court confirmed that wage comparison should be to that of other CEOs not to that of other employees within a company or other engineers or researchers.

The Suder case highlights that owners and other highly compensated executives who participate in R&D activities can be included in calculating the R&D credit.  It also highlights the importance of supporting documentation as evidence of participation in qualified research activities.

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Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

SourceHOV | Tax worked with this $30 million specialty packaging manufacturer to help it claim R&D tax credits for innovative packaging designs. The company performed hundreds of custom design packaging projects each year for a variety of customers.  The scope of this specific project involved the company’s work with a candy manufacturer that wanted a special container designed to hold gumballs. The product (gumball dispenser) was targeted at children, so in addition to having appropriate functionality so that the gumballs released properly, the design also needed to have play value.

Extensive research, experimentation and testing were conducted to ensure product safety and functionality. Research was performed on the materials selected for the packaging and the design of the gumball dispenser itself.  R&D included identifying the right combination of materials that would allow for a design that could be easily manufactured, shipped, stored and withstand the rigors of child play.

Over a five-year period, the company was able to claim R&D tax credits of $155,000 annually. The tax savings generated from these credits were used to conduct R&D to meet additional customer requests.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

In a late session Tuesday, the California Senate passed proposal AP93 that effectively repeals the California enterprise zone credit and replaces it with significantly scaled back hiring credits. The proposal largely retains the current geographic boundaries eligible for the credits and includes a sales tax exemption for manufacturing and biotech research companies as well as $30 million in the budget for tax credits that can be negotiated on a case-by case basis with the state.

The amendments would extend the carry forward provision for existing enterprise zone hiring credits to 10 years from the current five years, and a sunset provision on other parts of the program would be extended from five years or less to seven years. Additionally, ex-criminals would be eligible for hiring credits.

A priority of Governor Jerry Brown, this legislation is now headed to the Assembly where its future is uncertain.

SourceHOV |Tax is a national provider of specialty tax credit consulting services. If this legislation will cause a significant reduction in your EZ credits, we can help you identify other tax saving strategies such as R&D tax credits to offset the shortfall. For more than 30 years, SourceHOV | Tax has helped companies properly identify and sustain tax incentive strategies including R&D tax credits, cost segregation studies, 179D tax deductions and LIFO inventory accounting.  For more information, please call 800-806-7626 or visit www.sourcehovtax.com.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

After a multi-year court battle over R&D tax credits claimed by Union Carbide Corporation, the Supreme Court recently denied Union Carbide’s request for certiorari.  This denial makes the Second Circuit’s affirmation of the Tax Court decision final.  The Tax Court determined that Union Carbide was not entitled to research credits for the entire amount spent for supplies.

In this case, Union Carbide conducted three research projects to improve manufacturing processes. The research was conducted on products that were already in the process of being manufactured and were ultimately sold. Union Carbide claimed research credits for the additional cost of supplies associated with the research in addition to the cost of supplies used in production.

On audit, the IRS challenged the applicability of the credit for production supplies that would have been used regardless of any research performed.

The Tax Court concluded that Union Carbide was entitled to research credits only for the additional supplies used to perform the research. Costs for supplies used for actual production were found not to be research under the tax code. According to the Tax Court, these costs were “raw materials used to make finished goods that would have been purchased regardless of whether UCC was engaged in qualified research,” and that at best, these costs are indirect research costs and therefore excluded from the definition of qualified research expenses.

On appeal, the Second Circuit agreed that the costs at issue were, at best, indirect research costs that were excluded from the definition of qualified research expenses.

The case went to the Supreme Court who on March 18, 2013, declined to review it, making the Second Circuit decision final.

This decision continues to show the importance of identifying and tracking supply costs when performing research associated with new or improved manufacturing processes,  Many of these supply costs are tracked in general “cost of goods sold” or “inventory” accounts and are not readily identifiable, making research credit claims associated with these costs more difficult to support and defend.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

Governor Hassan Signs R&D Tax Credit Bill

Bipartisan Bill Doubles Tax Credit, Makes Measure Permanent

CONCORD – Enacting a key provision of her innovation plan to help businesses grow and create jobs, on March 21, 2013, Governor Maggie Hassan signed into law bipartisan legislation doubling funding for the state’s research-and-development tax credit and extending it permanently.

“Expanding the R&D tax credit is a critical component of our innovation agenda,” Governor Hassan said. “By doubling funding for the R&D tax credit, we can help more businesses develop in New Hampshire the new products that can lead to growth and job creation. Making the credit permanent will also help businesses who might need the credit down the road to plan ahead.

“Increasing funding for the research-and-development tax credit also sends a message to entrepreneurs and businesses considering where to locate that the State of New Hampshire will continue to work with them to encourage innovation and invest in our economic future.

Governor Hassan was joined for the signing ceremony by prime sponsor Senator Bob Odell and other members of the legislature, representatives from the economic development community, and New Hampshire businesses that have used the R&D tax credit, including Val Zanachuck, president of Graphicast in Jaffrey, an innovative small business that develops graphite mold casting technology to produce precision metal parts for a variety of industries.

“This legislation is a shining example of the tradition of collaborative, bipartisan problem-solving that the people of New Hampshire expect from their leaders,” Governor Hassan said. “Members of both parties, from both the House and the Senate, came together, shared thoughts and ideas, addressed concerns, and passed by overwhelming margins a common-sense measure to help businesses. By working together, we are sending a strong signal that New Hampshire is a state that welcomes innovation.”

“As a manufacturer, we have to constantly upgrade our manufacturing methods and processes to maintain a competitive business,” Val Zanchuck said. “New product development and process improvements are our R&D. For us, this R&D does not take place in a laboratory, it takes place on the shop floor. The R&D tax credit helps provide resources that we reinvest to improve and accelerate these activities.”

In addition to expanding the R&D tax credit, the Governor’s “Innovate NH” jobs plan focuses on building the best workforce in the country by making higher education more affordable and on providing businesses with technical assistance to help them create jobs.

Governor Hassan’s fiscally responsible, balanced budget substantially restores cuts made to New Hampshire’s public universities and community colleges in exchange for freezing in-state tuition for the next two years. Her budget proposal also will help New Hampshire’s businesses grow and attract new companies with good jobs by supporting economic development efforts, funding business incubators, and providing businesses with support to help them enter new markets around the world.

Deb Crumley, Director of R&D Tax Credit Consulting

Deb Crumley, Director of R&D Tax Credit Consulting

SourceCorp recently worked with a $6 million New York manufacturer to identify, document, calculate and claim the New York State Research & Development Tax Credit formally called the QETC. The company was able to go back and claim the credit for four years and claimed total credits of $328,474.

Subsequently, the owner was notified that state examiners intended to review the claim. SourceCorp met with the examiners and explained the client’s activities and expenses and their validity with regard to claiming the R&D credit. SourceCorp succeeded in sustaining 100% of the  credit for the company.

The QETC is a refundable credit, so this New York manufacturer was able infuse $328,474 into their business by evaluating what was already spent as part of the company’s initiative to stay competitive through research and development spending.