Taxpayers taking the Research and Experimentation (R&E) Tax Credit in 2018 have planning opportunities to increase their R&E credit as a result of The Tax Cuts and Jobs Act (the Act) due to changes that impact the computation of the IRC Section 41 credit.
Company’s eligible to take the Research & Experimentation Tax credit may take the full 20% credit but must reduce qualifying Section 174 research expenses by the amount of the credit. This expense reduction has the effect of increasing taxable income, and may have a state tax impact in states without a corresponding research tax credit.
Alternatively an election may be made under IRC Section 280C(c)(3) to take a reduced 14% credit without any adjustment to research expenses. The election for a reduced credit has historically been favorable for taxpayers in states that start with federal taxable income in computing state taxable income and do not allow an adjustment for the federal IRC Section 280C(c)(3) adjustment.
The research expense reduction prior to the Act was equal to the amount of the credit reduced by the maximum tax rate of 35%. The Act replaced prior graduated corporate tax rates with a flat 21% rate effective in 2018. Because of the federal income tax rate reduction, taking the full 20% credit may be more advantageous in 2018 and going forward, even if state taxable income increases slightly. An example is provided below.
The election to take the reduced credit or taking the full credit for the 2018 tax year depends on the specific overall tax position of the business. Other factors must be considered, including NOL’s, NOL carry-forwards, expiring credits, and state taxes.
Each tax situation is different resulting in different outcomes of how to minimize tax due to tax reform. In addition, the answer could change as additional guidance is issued by the IRS. Barnes Dennig is here to help assess your specific tax situation. For additional guidance please contact us here or call 513-241-8313.