The big winners of the Tax Cuts and Jobs Act (TCJA) enacted in December 2017 are obviously the C-corporations in America. For tax years beginning after Dec. 31, 2017, C-corporations will enjoy the following benefits:
* A significantly reduced maximum tax rate from 35% to 21%
* The elimination of corporate Alternative Minimum Tax
* An increased cash benefit associated with certain business credits such as the R&D tax credit
Increased R&D Tax Credit Benefits
Beginning with 2018 tax year returns, C-corporations will realize an increased cash benefit from their R&D tax credits. In previous years, the net tax savings associated with R&D credits was about 65% of the credit claimed on the federal return. In 2018 and subsequent years, the benefit will increase to about 79% of the credit.
For example, a corporation that paid federal taxes at a rate of 35% would have been required to reduce its business deductions by an amount equal to the R&D tax credit claimed, thereby raising the company’s tax liability. In the case of a $100,000 R&D tax credit claim, a company’s tax liability would have increased by $35,000 and the resulting cash benefit, after applying the tax credit, would have been $65,000. Today, with the maximum corporate tax rate set at 21%, the cash benefit of a $100,000 R&D credit will be $79,000.
Elimination of Corporate Alternative Minimum Tax
The elimination of corporate alternative minimum tax (AMT) in the TCJA will certainly benefit C-corps. Prior to enactment of the legislation, corporations were required to pay tax at a minimum rate of 20% regardless of any credits or deductions. With the elimination of AMT, corporations will have the ability to further reduce their tax bills using R&D tax credits.
Note, however, the TCJA retains the rule effectively known as the “25/25 limitation”, which prohibits corporate taxpayers with over $25,000 in regular tax liability from offsetting more than 75% of their tax liabilities using R&D credits.
Good News for Flow-thru Entities
For flow-thru entities such as S-corporations and LLCs, there is good news as well. While the shareholders of such businesses will still be subject to the higher individual tax rates, pass-through businesses will be allowed to take a 20 percent pass-through deduction on their “Qualified Business Income” (IRC Section 199A). The new 20% pass-through deduction rules can get quite complex, especially for taxpayers earning over the set income thresholds.
In addition, the new law permits all businesses to elect a 79% reduced credit under section 280C on IRS Form 6765 instead of a 65% reduction as in prior years. As such, the cash benefit of the R&D tax credits for flow-through entities could be as much as 79% of the credit.
The PATH Act of 2015 allowed eligible small businesses to use the R&D tax credit to reduce alternative minimum tax (AMT) as well as regular tax. The Tax Cuts and Jobs Act will continue to allow shareholders of enterprises having less than $50 million in average revenue over the prior three years to use the R&D credit to offset AMT. The owners of businesses or the combination of businesses having more than $50 million in revenue cannot reduce AMT on their individual returns.
Payroll Tax Offset
The PATH Act also provided tax relief for startup companies engaged in innovation, allowing small businesses to offset a portion of their payroll taxes using R&D credits. Such businesses interested in saving valuable payroll tax dollars should understand these key points:
* Qualified small businesses are defined as corporations having gross receipts of $5 million or less during the taxable year, and that did not have gross receipts for any year preceding the 5-year period ending with the taxable year
* Qualifying businesses may offset the 6.2% FICA portion of their payroll taxes using R&D credits claimed on their federal returns
* In any given year, the maximum payroll tax offset allowed is $250,000
* Unused credits can be carried forward and used against future payroll tax payments