Advantageous Tax Accounting Method After Tax Reform May be Available

The Tax Cuts and Jobs Act of 2017(TCJA) included many headline-grabbing changes for businesses like the lower corporate rate and the 20 percent deduction for pass-through.  One important provision that hasn’t gotten as much coverage is a change to tax accounting rules for small businesses that will allow more growing small businesses to qualify for smaller tax bills. 

For tax years beginning after December 31, 2017, business taxpayers with annual average gross receipts for the last three taxable years of less than $25 million now qualify to use the cash method of accounting when calculating taxable income. This increases the limit from the pre-TCJA cap of $ 5 million over the same period.

Taxpayers who might qualify for the new higher threshold need to re-evaluate their accounting methods, as a switch to the cash method can potentially yield an immediate tax benefit.

Eligible businesses that have been using the accrual method but now want to switch to the cash method will need to file an accounting method change Form 3115 with the IRS to switch to the cash method of accounting. An accounting method change and Form 3115 are filed by the due date (including extension) of the tax return for the year of change.                               

Changing from accrual to cash-basis for tax purposes

A switch to the cash method of accounting can result in significant tax savings for a business if:

• Accounts receivables and prepaid expenses are greater than
• Accounts payables, and accrued expenses.

Businesses will need to analyze these balance sheet items to determine if the cash method of accounting creates a favorable adjustment in the current year. When making an accounting method change, the law requires the taxpayer to calculate an adjustment amount for items on the opening balance sheet for the year of change. A net positive adjustment is absorbed into taxable income over the next four years; a net negative adjustment is claimed as a deduction in the year of change.

The illustration above would result in a favorable tax deduction of $390,000 in 2018. What does this $390,000 deduction mean from a tax savings perspective? In our example, the accrual to cash adjustment will save the taxpayer an estimated $81,900 of Federal Income Tax ($390,000 x 21 percent tax rate) in the year of change. As you can see, the method change can provide the most significant value in the first year.

Cash-basis Accounting Method

Companies that use the cash-basis method of accounting for tax purposes recognize revenue and expenses when the money comes in and goes out. Cash-basis entities generally have opportunities to postpone revenue recognition and accelerate payments at year-end. Under the cash basis, expenses are deductible even when a line of credit or other credit facility is used to pay expenses/invoices. This strategy can temporarily defer the company’s tax liability.

For smaller businesses, the cash method of accounting for tax purposes provides a more accurate reflection of cash flow and does a better job of matching revenues with the corresponding tax liability in the year that the cash is actually received. Although the taxpayer will remain on the accrual basis for GAAP and financial statement purposes, switching over to the cash basis for tax reporting changes the year-end tax planning conversation and strategy.

What happens if the taxpayer exceeds the $25 million in a future tax year?

Eligibility is determined annually based on the average gross revenues for the prior three years.  If a taxpayer’s average gross revenues exceed $25 million in the future, the taxpayer will be required to switch back to the accrual method. The deferred income related to that change is added back over a four-year period, similar to the adjustment described above.    

The sooner you change to cash-basis, the longer you benefit

The TCJA widens the pool of eligible taxpayers who qualify for the cash method of accounting.  In order to take full advantage of the provision, businesses should act quickly to determine if they benefit from the cash method and file the necessary election with the IRS to implement the change as soon as possible.

To learn more about changing from accrual to cash-basis for tax purposes, whether your business qualifies and how it might benefit, please call the Freed Maxick Tax Team at 716-847-2651 to discuss your tax situation, or complete and submit the form to schedule a complimentary Tax Situation Review.. 

For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.

Real property owners and developers often consider the federal Historic Tax Credit (HTC) when evaluating whether to acquire and substantially rehabilitate historic buildings. Unfortunately, the Tax Cuts and Jobs Act (TCJA) repealed the 10% federal HTC and modified the 20% federal HTC. These changes, which are effective for taxable years beginning after 2017, will likely impact the acquisition and rehabilitation of historic buildings.

Repeal of the 10% HTC

Before the TCJA, taxpayers could claim a 10% federal HTC for expenditures paid or incurred to substantially rehabilitate non-certified pre-1936 buildings. Unfortunately, the TCJA repealed this provision.

Modified 20% HTC

Before the TCJA, taxpayers could claim a 20% federal HTC for expenditures paid or incurred to substantially rehabilitate a certified historic building. The 20% federal HTC continues, but the timing for claiming the federal HTC has changed.

Before the TCJA, the federal HTC was claimed for the taxable year in which the certified historic building was placed in service after substantial rehabilitation. A “certified historic building” means a building which is listed in the National Register of historic places, or is located in a registered historic district and certified to the Secretary of the Treasury by the Secretary of the Interior as being of historic significance to the district.

The TCJA modified the timing for claiming the 20% federal HTC. Under the new rules, the federal HTC is claimed ratably over a 5-year period beginning with the taxable year in which the certified historic building is placed in service after substantial rehabilitation. This change impacts the overall return on investment for the rehabilitation of certified historic buildings.

In addition, excess federal HTCs generated for the taxable year in which the certified historic building is placed in service after substantial rehabilitation will diminish. Excess federal HTC’s means HTC’s exceeding federal income tax liability for the taxable year in which claimed.  Such excess HTC’s may be carried back to the immediately preceding taxable year by filing a carry back claim resulting in a refund of federal income taxes paid in the preceding tax year. However, under the new rules, the ability to generate excess HTCs will diminish.       

Listen to a podcast from Freed Maxick Tax Director Don Warrant on how the Historic Tax Credit can generate 40% cash reimbursement for property owners.

Transition Rule

The TCJA provides a transition rule whereby the changes made by the TCJA do not apply to expenditures paid or incurred by the end of the taxable year in which the 24-month period, or 60-month period, ends when the following two conditions are met:

1. The building was owned or leased during the entirety of the period after December 31, 2017, and

2. The date of the beginning of the 24-month or 60-month period is no later than June 20, 2018.

The 24-month period and the 60-month period are in reference to the period over which the certified historic building must be substantially rehabilitated.

Under this transition rule, all expenditures should be paid or incurred by the end of the taxable year in which the 24-month or 60-month periods end.  

Tax Basis Reduction Rules

The TCJA did not affect the rule that requires the tax basis of the certified historic building to be reduced by the amount of the HTC claimed. Generally, tax basis reduction rules don’t apply when federal tax credits are claimed over multiple tax years. Fortunately, a bipartisan group of House and Senate lawmakers introduced legislation that would eliminate the rule that requires the tax basis of the certified historic building to be reduced by the amount of the HTC claimed. However, no further action has been taken on this legislation as of the time of this writing.  

State Impact

States that follow the federal HTC rules may adopt the changes made by the TCJA or decouple from those changes. 

For example, New York State provides a refundable HTC equal to the amount of the federal HTC. However, New York State has decoupled from the changes made by the TCJA. Therefore, taxpayers can continue to claim the 20% New York State HTC for the taxable year in which the certified historic building is placed in service after substantial rehabilitation.

For Further Clarification and a Discussion of Your Situation

The Freed Maxick Tax Team has significant experience when it comes to helping real property owners and developers qualify for and claim historic tax credits as well as other Federal and state tax credits. With an ever-changing tax landscape, our team is prepared to assist real property owners and developers to minimize their income tax liabilities using the various tax credit and incentive programs, and other tax minimization strategies.

For more information on how the changes made by the TCJA might impact your historic rehabilitation project, or to discuss other changes made by the TCJA, please call us at 716.847.2651 or contact us here.

How to determine the correct transfer pricing strategy for your business in the new tax environment

On December 22, 2017, the federal Tax Cuts and Jobs Act (“The Act”) was signed into law creating one of the largest tax overhauls in history. Though there were no direct changes to the transfer pricing requirements, certain international provisions implemented through the Tax Act may create an impact on transfer pricing.

These provisions include, but are not limited by, Foreign-Derived Intangible Income (“FDII”), Global Intangible Low-Taxed Income (“GILTI”), Base Erosion Anti-Abuse Tax (“BEAT”), and the definition of intangible property. It is important that companies review their existing transfer pricing policies or take these provisions into consideration when creating a new policy to ensure that they comply and maximize all tax planning opportunities.

Foreign-Derived Intangible Income (“FDII”) & Global Intangible Low-Taxed Income (“GILTI”)

The FDII provision of The Act creates an incentive for U.S. corporations that sell, lease or license intellectual property to retain their assets in the United States by providing a preferential tax rate on that foreign-derived income.  Thus, with a special rate of 13.125 percent, a domestic corporation with foreign affiliates might find it advantageous to shift intangible leasing profits into the United States. 

As the counterpart to FDII, The Act’s provision on Global Intangible Low-Taxed Income was designed as a safe-guard to combat a U.S. corporation’s attempt to shift profits overseas to take advantage of the new territorial system.  Briefly, GILTI imposes penalties on organizations that derive income from foreign intangibles harbored in low-tax jurisdictions.  The tax subjected could render a territory less advantageous when contrasted to pre-tax reform.

A U.S. corporation should consider FDII and GILTI in determining which taxing jurisdiction to house its intangible assets.  Tax incentives to source profits to the U.S. include lower rates and avoiding penalties which might outweigh the tax benefits of foreign sourcing going forward.

Intangible Property

With the above provisions affecting the tax of intangible assets, it is relevant to note that the definition of intangibles has also been amended with The Act to include anything with potential value that is not attributable to tangible property. Further, valuation of intangibles has been challenged with The Act, giving the IRS the authority to value transfers of intangible assets on an individual basis, in the aggregate, or by any other means deemed reasonable. The modification of the definition itself could potentially diminish the reliability of existing transfer pricing policies and the wording of said policies should be reviewed.

Base Erosion Anti-Abuse Tax (“BEAT”)

BEAT is an additional tax that applies to corporations that have average annual gross receipts of $500 million and have foreign deductible related-party payments totaling at least 3% of the sum of all annual deductions.  The tax is computed as a multiple of the sum of the corporation’s taxable income and the deducted foreign related-party payments.  Although BEAT does not apply to all related-party payments, susceptible corporations should be wary of large base erosion transactions that are material to total deductions going forward.  The adverse cost of BEAT could perhaps outweigh the advantages of transacting with foreign affiliates. 

Assessing the Impacts on Your Company’s Transfer Pricing Strategies

With all of the above provisions being effective January 1, 2018, now is a good time to assess their impact on your transfer pricing strategy and policies. If you have not done this already, there are still plenty of transfer pricing planning opportunities that can be utilized for the 2018 tax year. 

The International Tax team at Freed Maxick CPAs, P.C. has been monitoring these provisions closely and is ready to discuss how your business may be impacted. Connect with us to schedule a Tax Situation Review so we can provide guidance on how to maximize planning opportunities and optimize your transfer pricing strategy.

You can reach us at 716.847.2651 to schedule a review today.

New Tax Law, Same Old Question: What’s the Best Entity for Your Business

The Tax Cuts and Jobs Act of 2017 (TCJA) made some of the most consequential changes to business income taxation in decades. With a new, significantly lower and flattened corporate tax rate, reduced personal rates, and a 20 percent deduction for income from flow-through entities, the act altered several variables in the equations that executives use to determine the most tax-efficient structures for their businesses. As a result, many leaders are asking how to re-evaluate the choice of entity and what amount of tax advantage warrants such a fundamental change. There are no simple answers to these questions, but this discussion provides a quick overview of some of the key criteria.

Many executives are surprised to learn that the new tax rates and the 20 percent deduction are actually some of the less complicated factors to analyze in a choice-of-entity re-evaluation. Here’s a quick review of C-corporation v. flow-through taxation and the effect of the new law on each:

• C Corporations pay an entity-level income tax and income distributed to shareholders is taxed again at the individual level.

The TCJA significantly decreased the corporate tax rate from a top marginal rate of 35 to 21 percent. As a result, a sole shareholder of a C Corporation that distributes all of its after-tax earnings would face an effective federal income tax rate of approximately 39.8 percent.

• Flow-through entities are not subject to federal income tax at the entity level. All income generated from the business is reported and taxed on the owners’ individual income tax returns.

TCJA did reduce the tax rates on individuals, but the drop was not as significant as the reduction in corporate rates. Top earners went from a maximum rate of 39.6 to 37 percent (40.8 percent once the Medicare surtax is tacked on).

So C Corp seems to be the way to go right? Not so fast…

A New Twist – A Deduction for “Qualified Business Income”

Congress also created a new deduction for qualified business income from eligible flow-through entities. The new deduction allows for a deduction of up to 20 percent of qualified income. Owners of a business that qualifies for the full deduction amount could face a top federal effective tax rate of 33.4 percent.

So who qualifies for this special new deduction?

Unfortunately, the new law has temporarily left us with more questions than answers. What we know at this point (Fall 2018) is that income from businesses in the fields of health, law, accounting, investment management and consulting is not subject to the deduction if it exceeds $157,500 in a year ($315,000 in the case of a joint return).  

In addition, a business is ineligible for the deduction if its “principal asset” is the “reputation or skill” of one or more employees and/or owners. The Freed Maxick Tax Team is still awaiting further guidance as to what the lawmakers meant to exclude with this language.

But Wait, There’s More…Other TCJA Provisions that Should be Considered in a Business Entity Selection Evaluation

The rate changes and flow-through deduction are the most obvious changes to the entity choice calculation, but the tax code is full of other provisions that should be considered in a re-evaluation, including:  

• Taxes on international income will play a much bigger part in the choice of entity under the TCJA. Businesses with any type of international operations will need to consider the new global low-tax intangible income (“GILTI”) and foreign-derived intangible income (“FDII”) provisions.

• GILTI applies to income generated by a company’s controlled foreign C corporation and creates an additional U.S. tax liability on the overseas profits.
• FDII provides a tax advantage for income generated by a U.S. taxpayer from:
  • The sale of tangible property for foreign use, or
  • The performance of services for foreign customers where the benefit is derived by a foreign customer in a foreign location.

For a more extensive discussion of these two provisions read our related articles about GILTI here.

• Qualified small business stock (QSBS) treatment may allow individuals to exclude gain on sale of their stock if it meets certain criteria including but not limited to:

a.) acquired as part of an original issue by a domestic C corporation

b.) had no more than $50 million in assets as of the date of stock issuance

c.) engaged in a “qualified trade or business”, examples of certain types of business specifically excluded from the definition of “qualified trade or business” include health, law, engineering, architecture, accounting, consulting, athletics, banking, insurance, investing, restaurants, and hotel/hospitality

State Tax Considerations Regarding Business Entity Selection Choices

Your business cannot afford to forget that state and local taxes play a huge part in determining the tax advantages of a particular entity choice. Depending on where your business operates, the amount and type of activities it performs in those locations, and the applicable tax rates, the impact of non-federal taxes can always sway an entity choice to one side of the fence or the other.

For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.

Stay Tuned

As with many tax discussions the devil is in the details. Given the amount of guidance still to come from the IRS, we don’t even have all of those details yet. Be sure to subscribe to Freed Maxick’s e-mail service for updates as new information becomes available.

Meanwhile, if the issues discussed in this article have you wondering about choosing a business entity and if you need to reevaluate your selection, it’s never too early to start the discussion. Please contact Freed Maxick via our contact form, request a Entity Selection consultation, or call us at 716.847.2651 to discuss your situation.

The IRS has released a new notice aimed at clarifying the effect of the TCJA on the deductibility of business meals and entertainment. According to the Service, "Taxpayers may continue to deduct 50 percent of the cost of business meals if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant. The meals may be provided to a current or potential business customer, client, consultant or similar business contact." 

The notice lists 5 tests for deductibility. Taxpayers may deduct 50 percent of an otherwise allowable business meal expense if: 

1. The expense is an ordinary and necessary expense under section 162(a) paid or incurred during the taxable year in carrying on a trade or business;
2. The expense is not lavish or extravagant under the circumstances;
3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
4. The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
5. In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages. 

The notice also announces that Treasury and IRS plan to publish proposed regulations on the issue. Comments are requested by December 2 of this year regarding the guidance in the notice, so it seems likely that the regulations would be published some time after that. 

To learn more about how this notice affects the deductibility of your business meals and entertainment, or address any questions you may have, please contact us here or call the Freed Maxick Tax Team at 716.847.2651 to discuss your situation.

Microbreweries often experiment with flavors and processes in ways that may qualify for a significant federal tax credit.

When craft brewing is done right, it often seems more like art than science. So it should come as no surprise that many craft-brewers overlook a tax-saving opportunity that is more closely associated with science-based industries like pharmaceuticals and tech companies.

The Federal Research & Development (R&D) tax credit provides a federal tax credit based on certain expenditures business spend on “qualifying research activities” (QRAs).  Additional incentives are available for certain startups and smaller breweries, such as credit against certain payroll taxes and not being limited by the alternative minimum tax.

Qualifying Research Activities for Breweries and Microbreweries

That phrase “Qualified Research Activities” is the heart of the argument for applying the credit to certain microbrewery expenditures. Costs related to an activity that meets the four-part test to qualify for the R&D credit, regardless of the industry in which the business operates.

Examples of qualified activities for Breweries and Microbreweries include, but are not limited to:

1. Developing new or improved hopping techniques, including testing new varieties or combinations of varieties. In fact, according to gardeningknow.how.com, there are about 80 different hops types commercially available. It’s not unreasonable to think that many others are in development.
2. Develop new or improved malting, lautering, fermenting, or conditioning processes.
3. Developing new or improved bottling processes to improve shelf longevity, lower cost, or other functional improvements,
4. Improvements to your brewing process to reduce waste, improve water recycling throughout the process, improve filtration, reduce cycle time, or other functional aspects,
5. Development related to new product formulations, including use of different ingredients or preservatives.

Deductibility is in the Details

The potential benefits of the R&D credit are significant, so the government requires thorough documentation. If you’re planning to claim the credit, you’ll want to set up your accounting system to track QRAs in separate accounts. Time allocations for employees engaged in R&D are an important part of your records.  Actual timesheets and payroll records are the strongest support.  These can be supplemented with post-completion analyses of resources used, design drawings for proposed developments/improvements, meeting notes, and testing documentation.

Extra Benefits for Start-Ups and Small Businesses

The IRS rules don’t go into specifics about what constitutes sufficient documentation for any particular claim, but they do express a strong preference for contemporaneous documentation. If you’re planning to claim the R&D tax credit for your brewery or microbrewery, it’s important to consult with a knowledgeable professional at the outset (or as soon as possible after starting!) to build the system that will document your costs accurately as you go.

The PATH Act of 2015 made the R&D credit permanent and even more valuable to microbrewery start-ups and small businesses. If you are a brewer with less than $5 million in current-year gross receipts and no gross receipts for any tax year that precedes the fourth preceding tax year, you can elect to claim up to $250,000 of the credit against your employer portion of Social Security tax. Partnerships, sole proprietorships and privately held corporations whose average annual gross receipts for the last 3 years that do not exceed $50 million, can also claim the credit against an alternative minimum tax liability. 

State Incentives for Brewers in New York

The Empire State also offers several incentives for brewers operating within its borders. Credits for investment in buildings and equipment apply to brewers, as do income and property tax credits for manufacturers. New York also provides an alcoholic beverage production credit and, for locally sourced beers, some reduced permit requirements. In addition, breweries can qualify for the state’s START-UP NY business incentive program, depending on their location.

Brewing Up Your Credit

Securing both Federal and New York State credits and incentives requires detail analysis and documentation.  In some cases this will require presentation to tax authorities in an audit to defend your position.

That’s why you’ll want to work with a team of experts with impeccable credentials in helping businesses of all types and sizes use the R&D Credit -and other tax minimization strategies – to lower their tax burden.

For more information about how your microbrewery could benefit from the R&D tax credit, please contact Freed Maxick at 716.847.2651.

For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.

Six clarifications regarding the 20% deduction for passthrough businesses

The new tax law enacted in December of 2017 included many noteworthy provisions. In some cases, the law generated more questions than answers about how taxes would look in 2018 and beyond. One provision that couldn’t be fully understood without significant guidance from the IRS was the 20 percent deduction for passthrough businesses, or “Section 199A.”

Congress created Section 199A so that owners of these entities could deduct a piece of their business income “off the top” before calculating their personal tax. That sounds simple enough in theory, but in order to give businesses a break without creating a wealth of opportunities for tax avoidance, certain limitations and special circumstances needed to be addressed.

Clarifying How Section 199A Will Work in Practice

The IRS recently released several pieces of Section 199A guidance designed to clarify how the law would apply in practice.

• Operational rules: This section takes Congress’ legislative language and begins to translate it into instructions on a tax form. It covers the nuts and bolts of how the provision works when there are no special circumstances to address. For instance, many taxpayers will fall within the income limits ($315,000 for joint returns or $157,500 for other filers) that allow them to take the full 20 percent deduction from their passthrough income. Those folks may have a relatively uncomplicated calculation to determine their deduction.
• Limits based on wages paid: In some situations, the deduction may be limited based on a percentage of the wages a passthrough business pays to employees. The guidance includes 3 possible methods for calculating this limitation.

• Limits calculated from basis in acquired property: The regs offer guidance on limitations based on an owner’s basis in different types of property. Given the variety of property types and special circumstances based on the timing of property transactions during the year, the calculation of the deduction limitation gets very complicated if this section applies.
• What constitutes "business income?" If the only passthrough businesses these rules had to cover were grocery stores owned by Mom and Pop as partners, it would be pretty easy to determine what M & P’s business income was. However, passthroughs can be created to invest in other passthroughs and they can have a wide variety of income types that may or may not look like income from a business. In addition, some types of income might be business income for some businesses but not for others. For instance, income from real estate holdings could be business income to a real estate partnership, but not to a grocery store that owns its building and rents space to tenants.
• Aggregating business income for owners of multiple passthroughs: Many taxpayers own interests in multiple passthrough entities. The rules allow taxpayers to aggregate multiple entities for purposes of applying the wage and property limitations.
• Provisions aimed at keeping businesses from turning employees into small businesses: Congress intended for Section 199A to deliver tax relief to passthrough entities that would be comparable to the tax rate relief it enacted for corporations. It was not their intent to encourage every employer and employee to recharacterize their relationship as contractor and contractee in order to game the system. The guidance includes rules aimed at limiting the ability of businesses to make such a change. 

The recent Section 199A guidance covers a lot of ground when it comes to answering questions raised by the 2017 law. But much of what the IRS has released is “proposed” guidance, meaning that it’s not the last word on the topic. and the Service expects to hear from tax professionals and taxpayers about questions the guidance didn’t answer as well as new questions that have arisen as a result of the guidance.

Connect with Us to Discuss Your Section 199A Opportunity

If your tax return includes income from a passthrough business, you need to stay in touch with your tax adviser in the months ahead to understand just how the new law will affect you in 2018 and beyond.

If you want to discuss your situation and eligibility for the 20% deduction, please email me at Mike.VanRemmen@FreedMaxick.com or call me at 716.847.2651. As always, if you need additional information about any aspects of the Tax Cut and Jobs Act, please contact the Freed Maxick Tax Team.

Tax Cuts and Jobs Act of 2017 didn’t change the R&D Tax Credit, but the repeal of the corporate Alternative Minimum Tax (AMT) expanded the potential benefit to all corporations that were in AMT.

The Tax Cuts and Jobs Act (TCJA) enacted at the end of 2017 did not make specific changes to the research and development (R&D) tax credit, but one significant change to the corporate tax system could benefit businesses that claim the R&D credit on their returns.

TCJA repealed the corporate alternative minimum tax (AMT) for taxable years beginning after December 31, 2017.  As a result, the new law could make all corporate tax credits and carry forwards, including the R&D credit, more valuable in the next few years. 

Corporate AMT and R&D Tax Credits

Before TCJA, a corporation that was subject to the AMT in one year could take an offsetting AMT credit in subsequent years only to the extent that its regular tax liability exceeded its tentative minimum tax. Some corporations were perennially subject to AMT tax and the AMT credits increased over time and were unusable.

Refund of AMT Credit Carryforwards. Under the new law, any AMT credit carryforwards that weren’t used before the AMT was repealed can now be used to offset the corporation’s regular tax liability. The credit carried forward can be refunded in an amount equal to 50 percent of the excess of the credit for the tax year over the amount of the credit allowable for the year against regular tax liability. (That increases to 100 percent for tax years beginning in 2021.)

Corporations that have AMT credit carryforwards may now get an additional benefit from the R&D tax credit. To the extent the R&D credit reduces the regular tax liability, it could also accelerate the amount of AMT credit carryforwards that could be refunded during the “50 percent” years.

R&D Tax Credit Application for All Corporations and Not Only Eligible Small Businesses

In a previous blog, we discussed provisions of a 2015 law change that allowed only certain “eligible small businesses” (ESBs) to apply the R&D tax credit against their AMT due. Under current law, it appears that this benefit would apply to all corporations, regardless of whether they previously qualified as ESBs for purposes of deducting the R&D tax credit from their AMT liabilities. In effect, the elimination of the AMT under the TCJA has expanded the benefit to all corporations. The availability of the R&D credit to ESB would still apply to individual partners or S corporation shareholders who are subject to the AMT on their personal returns.

Connect with a Freed Maxick R&D Tax Credit Expert

Calculating and claiming the R&D credit for a corporation is a complicated process, and it’s made even more challenging if your business is carrying forward AMT credits from prior years.

If you have any questions or concerns about how the AMT and the R&D credit affect your personal or business taxes, connect with us by clicking on the button or please call the Freed Maxick Tax Team at 716.847.2651 to discuss your situation.

Individual Owners of “eligible small businesses” can use their R&D tax credits to reduce alternative minimum tax liabilities.

The Tax Cuts and Jobs Act (TCJA) enacted at the end of 2017 did not make specific changes to the research and development (R&D) tax credit, but some of the changes could still provide a little benefit to individual partners and S corporation shareholders who claim the R&D credit on their returns and are subject to the alternative minimum tax (AMT). For example, the amount of income that is exempt from AMT has been raised and so has the phase out of this exemption.

In a previous blog, we discussed provisions of a 2015 law change that allowed certain “eligible small businesses” (ESBs) to apply the R&D tax credit against their AMT due.

Passthrough AMT and R&D Tax Credits

Despite some efforts in the House to repeal the entire AMT instead of just the corporate version, the tax still applies to individual income taxes. As a result, S-corporation shareholders, partners, and sole proprietors need to understand how the AMT offset for ESBs might apply on their individual returns. This post will look more closely at how the credit “flows through” from the ESBs to the personal returns of qualifying owners.

To qualify as an ESB, the average annual receipts of a partnership, S-corp or sole proprietorship for the three-tax-year period prior to the tax-year of the R&D credit claim cannot exceed $50 million. This limitation also applies at the individual level.  Once the business qualifies as an ESB at the entity level, it’s up to each individual owner to determine whether and what portion of an R&D credit could be applied against his or her personal AMT liability.

Calculating R&D Tax Credit Against AMT

That calculation involves figuring out the percentage of personal income attributable to the passthrough credit-eligible activity. For example, assume that $100,000 of profit flows through the business to owner X and the business pays owner X wages of $50,000. X has income from a variety of other sources totaling an additional $50,000.  In addition, $10,000 of R&D credit flows to X from the passthrough entity.

For purposes of this example assume X has a tax liability of $12,000 this year, all of which is AMT.  To figure out how much R&D credit X can use to offset that liability, X needs to calculate the percentage of income attributable to the business. In this case, the profit of $100,000 and the wages of $50,000 are attributable to the business, a total of 75 percent of X’s total taxable income of $200,000. Therefore, X can use the R&D credits to offset 75% of the tax liability or $9,000. 

Of course, in real life the calculations are rarely this simplistic and some limitations could apply. In addition, many questions about taxation of passthroughs under the TCJA have yet to be answered. The law allows owners a deduction of 20 percent of the income from a passthrough, but the Treasury and IRS still need to provide guidance on how that will be implemented on 2018 returns. We will provide updates as that guidance becomes available.

Talk to a Freed Maxick R&D Tax Credit Expert

Before spending, consider these 2 additional R&D tax credit tests from the experts at Freed Maxick

We’ve written a lot about how the Research and Development (R&D) Tax Credit delivers tax savings for businesses with qualifying activities. 

It’s important to know that claiming the Credit involves preparing a detailed study, documentation, and interactions with the IRS. Most firms engage a professional to help them claim the credit and consider the fees they pay as an investment. 

In our work helping businesses identify costs and calculate the credit, we’ve noticed that even though some businesses may have expenses that meet the 4-part test, they may still not benefit from the credit because of circumstances that limit its applicability. 

That’s why our R&D Tax Credit Team does a Situation Assessment prior to an engagement. That includes performing two initial additional “tests” complementing the 4-part test that can identify factors limiting your company’s ability to claim the credit. 

If the company does not pass these tests, we may recommend deferring activities pursuant to claiming the credit until a later date. These include: 

Additional Test 1: Do You Own the Risks and Rewards of the R&D Activity? 

If a business is hired to conduct qualified research activities by another business, the claim for the credit will generally flow to the business that bears the risk of failure and owns the rights to success. Businesses may be hired to develop a product or process by another company. These contracts often call for the researching business to receive a fixed fee for the work regardless of result and it transfers the rights to the results to the hiring business. 

Even though research costs might qualify for the credit, the company that hired the research business would be the one to claim it. 

The determining factor in a situation like this will be the contract between the two companies. If your company performs research on a contract basis for other businesses, it’s important to consider the value of the R&D tax credit when negotiating a contract. 

Your business might still end up in a better position if you are paid regardless of result, but understanding the value of the tax credit foregone can lead to more equitable pricing for both parties. 

Additional Test 2: Do You Owe Taxes? 

In addition to the ownership of risks and rewards, businesses sometimes find that they qualify for a credit but can’t claim it in the current year because they aren’t making money, and therefore have no tax liability.  For individuals, alternative minimum tax (AMT) limitations could prevent one from claiming credit, but recent tax changes significantly increased the AMT exemptions and therefore reduced the likelihood that AMT would limit credit on an individual taxpayer level. 

The R&D Tax Credit is not a refundable credit—it can reduce the balance of taxes that you owe, but if you don’t owe taxes it will not generate a refund. The PATH Act, passed in 2015, allows certain start-up businesses to apply the credit against payroll taxes owed, but if you don’t qualify for that break your business will have to carry the credit forward until a year in which it owes taxes. 

So, it may not make sense to invest in having an expert conduct an R&D study and prepare the documentation for claiming the credit.  However, at the time when you have taxable income, claiming the credit may be a prudent strategy … assuming the tax benefit you’ll receive is greater than the cost of the study that needs to be performed!  Regardless of when you do the study, you will want to maintain good internal documentation.  If you do multiple years of R&D credit claims together it is important to have good R&D tax credit documentation so you aren’t “recreating” records and reduce audit risk. 

Connect with a Freed Maxick R&D Tax Credit Expert

The important thing to remember is that a claim for the R&D Tax Credit requires careful planning. If you’re looking to hire research on a contract basis or to perform research for hire, your agreements should reflect an understanding of the value of the credit and who will have the right to claim it. 

If your business performs R&D activities but isn’t yet profitable enough to claim the credit now, you need to understand how soon you will get the value of those expenditures back on your tax return. 

These can be complicated issues, and it’s our recommendation that before pulling the trigger on a R&D Tax Credit Study, you look at applicability issues in detail. 

We can help. 

In a 30-minute phone call we can identify whether you’re eligible for the credit and if it makes sense to proceed with a claim. 

To discuss your situation contact us by clicking the button or call us at 716.847.2651.