USA: New legislation on the horizon to help start-ups take advantage of research and development tax
07 August 2014
Posted by: Author: Lourdes E. Perrino
Author: Lourdes E. Perrino (Taft Stettinius & Hollister LLP)
Congress is currently considering two tax credit bills that have the potential to substantially increase profits of start-up tech companies: the Startup Innovation Credit Act of 2014 and the Innovators Job Creation Act. As discussed in more detail below, the Startup Innovation Credit Act of 2014 would amend the Internal Revenue Code of 1986 (the "Code”) to provide for start-ups to use a portion of the existing research and development ("R&D”) tax credit to offset payroll taxes. The Innovators Job Creation Act would amend the Code to: (1) make permanent the tax credit for increasing research activities; (2) allow an offset of such credit against liability for the alternative minimum tax; (3) make permanent the five-year carryback of research tax credit amounts of certain small businesses; and (4) allow a qualified small business, other than a tax-exempt organization, to use a portion, up to $250,000 in a taxable year, of its tax credit for increasing research expenditures as an offset against its employment tax liability.
The Startup Innovation Credit Act addresses the problem that small start-ups tend to be unable to take advantage of the existing R&D tax credit (a tax credit granted for research and development expenses that a company can take against its income tax liability). Because most start-ups do not turn a profit within their first few years of business, they often have no income tax liability against which they can take the R&D credt. The Startup Innovation Credit Act seeks to change this problem by allowing qualified new small businesses to apply the R&D tax credit to payroll tax (including FICA) rather than income tax. Start-ups can use this act to make effective use of the original R&D tax credit.
To qualify for this tax credit, a corporation or partnership must meet the following requirements:
- The company must have existed for less than five years.
- The company must have grossed less than $5 million for the taxable year in question.
- The company must not be exempt from taxation under §501 of the Internal Revenue Code of 1986 (e.g., agricultural organizations, labor unions, etc.).
- The company must not have elected to use this exemption for five or more preceding years.
If a corporation or partnership qualifies for this tax credit, it may then exclude up to $250,000 from its taxable income. Individuals may also use this credit if their participation in a particular trade or business and the aggregated gross receipts related to it meet the above requirements.
The Startup Innovation Credit Act is not yet law; it was originally introduced to Congress in 2012 and is currently part of a tax credit extenders bill that has been introduced to the House of Representatives. As this special application of the R&D tax credit must be used within five taxable years of a company’s creation and can only be applied for five years thereafter, start-up tech companies should keep a close eye on this bill to take timely advantage of it should it be passed.
The Innovators Job Creation Act was also introduced this year, though to the Senate rather than the House of Representatives. This act includes the contents of the Startup Innovation Credit Act in their entirety and provides other benefits to businesses that are not startup companies, especially small businesses. The act defines "small businesses” as corporations, partnerships or sole proprietorships that gross less than $5 million a year.
If enacted, the Innovators Job Creation Act would allow any business to choose to apply the R&D research tax credit against its alternative minimum tax. The R&D act itself would also be modified; the Innovators Job Creation Act makes the credit permanent where previously it was a temporary credit that has been continuously renewed since 1985. Additionally, the act would grant small businesses a permanent five-year carryback for R&D credits.
The Innovators Job Creation Act would also modify the Internal Revenue Code covering alternative simplified credit, which can be used in place of the R&D tax credit. The act would make this credit permanent and allow it to be applied retroactively, just as with the normal R&D tax credit. This credit is normally equal to 14% of a company’s qualified research expenses that exceed 50% of the company’s average qualified research expenses for the preceding three years.
The benefits of these modifications are numerous. Besides allowing small businesses and startups to profit by selectively applying their R&D credit in the way that is most beneficial to them, it allows these businesses to do so retroactively. Due to the carryback rule for the R&D credit, a small business may use any of the aforementioned special applications of the R&D credit for a previous taxable year by filing an amended tax return for that year. A small business would be able to retroactively apply their R&D credit to their alternative minimum tax or to their alternative simplified credit, and startups would have the additional option of applying their R&D credit to their payroll tax.
While the Innovators Job Creation Act undoubtedly provides more benefits to a wider range of businesses, the passage of either bill would be a boon to the tech industry in general and would allow many start-ups to take advantage of credits that have previously been beyond their reach.
This article first appeared on lexology.com.