When it comes to claiming R&D tax credits, many taxpayers are unaware of the rules allowing them to carryforward the unused portion of their research tax credit. In most situations, a company who has qualifying research expenses but no income can carryforward the credit to offset tax liabilities on future profit. Any unused R&D credits will carry forward for up to 20 years. In addition to carryforwards, the research tax credit can also be carried back one year.
Prior to the enactment of the PATH Act, taxpayers were unable to realize the full benefit of their R&D tax credits in a given year due to AMT restrictions. The AMT limitation prevented qualified companies from utilizing the 100% of the tax credit; consequently, the excess R&D tax credits were carried forward. The PATH Act 0f 2015 was one of the first initiatives to make significant changes in the relationship between AMT and the R&D tax Credit. For tax years beginning after December 31, 2015, small businesses can offset AMT using the research credit against . However, any carryforwards from tax years prior to 2016 are still limited by AMT.
Fortunately, the Tax Cut and Jobs Act (TCJA) eliminated AMT for C-corporations providing these companies the opportunity to further reduce their tax bills using past, present and future research tax credits.
However, there is one rule effectively known as the “25/25 limitation” that has not changed. This rule restricts taxpayers with over $25,000 in regular tax liability from offsetting more than 75% of their tax liability using the credit (Sec. 38(c)(1)).
A start-up software company is eligible for the R&D tax credit. The company had losses for its first 3 years (2016 – 2019). In 2020, the company becomes profitable and chooses to claim R&D credits for the current year as well as the three previous years to create a carryforward that they plan to use in 2020. The company calculates a total of $100,000 in research tax credits and has a federal tax liability of $120,000. However, due to the 25/25 limitation, it can only apply $90,000 of the credit to offset its tax liability. The remaining $10,000 will be carried forward to the subsequent year.
TCJA Effects on NOL Carryforwards
For all taxpayers, the TCJA amended Sec. 172(a) for tax years beginning after Dec. 31, 2017, by adding a new limitation on the use of net operating losses (NOLs) that restricts their use to 80% of taxable income. The new 80% taxable income limitation may require some taxpayers to seek additional tax savings opportunities, such as the R&D tax credit.
Under the CARES Act, NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2021 may be carried back to each of the five tax years preceding the tax year of such loss. In addition, the CARES Act also temporarily removes the 80% limitation, reinstating it for tax years beginning after 2020.
State Carryforward Rules
Many states also allow unused R&D tax credits to be carried forward. Some mirror the federal carryforward guidelines of 20 years while others range anywhere from zero to eternity. In California, for example, there is currently no limit on the carryforward period.
How We Can Help
Now is a good time to reexamine prior, current, and future R&D activities in order to take advantage of the R&D tax credit, regardless of industry. If you think your company might be performing work that qualifies, don’t let the potential tax savings go unclaimed. Intrepid Advisors can help you uncover vital tax savings to reinvest in your business and fuel your next big project.
The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.