R&D Tax Credit for Manufacturers: Help Offset the Costly Alternative Minimum Tax (AMT) [Blog Post]
August 18, 2016 - By: SC&H Group
In the following blog post, Angelo Poletis, a Principal with SC&H Group’s Tax Services team, provides insight into how manufacturers can take advantage of an important tax credit for research and development that can help offset the costly alternative minimum tax (AMT).
Manufacturers can take advantage of a valuable research and development tax credit to fund future expansion – and to also help offset the costly alternative minimum tax (AMT).
Statistically, manufacturers have not leveraged the credit allowed for research and development to date based on uncertainties surrounding length of time before expiration, and costs for eligibility. Thankfully, in December 2015, the law was changed to make the credit permanent, and provide more guidance for determining eligibility.
Now, qualifying activities for eligibility must involve a process intended to eliminate uncertainty for the development or improvement of a component or the component’s design. The activity must be for the purpose of technological experimentation. Expenditures related to taste, cosmetics, or incurred in production would not qualify. For example, the Internal Revenue Service (IRS) has indicated that preliminary and critical design reviews are likely to qualify for the credit, and quality control costs will likely not qualify.
For small and mid-size businesses, having the credit reduce AMT opens an opportunity to offset current year income to generate instant cash-flow. (See IRS Tax Topic 556). In recent years, the AMT applied to more individual taxpayers than ever before.
What the writers of the tax laws previously failed to recognize is that more and more businesses are set up as pass through entities. As a result, S corporation shareholders and partners in partnerships are recognizing more taxable income. This is not because they’re bringing in more cash – the business income is passing through to their individual returns. This artificially inflates the shareholder/partner income, making them more susceptible to the AMT.
For many S corporation shareholders and individual partners in partnerships, AMT created a problem that is counterintuitive to the purpose of the research and development credit. The research credit was enacted to encourage businesses to spend funds on qualified research and they, in turn, would be rewarded with a credit against income taxes.
Unfortunately, the research credit was of limited value because it couldn’t be used to offset the AMT. The credit couldn’t be used in the current year, but carried forward in hopes of landing in a year when the shareholder/partner wasn’t in AMT. In other words, if the shareholder/partner was in AMT, they’re paying the same amount of tax in the current year.
To give tax law writers a pat on the back, under the new tax law signed in December 2015, the research credit can now offset AMT for small businesses starting in tax years beginning in 2016. A small business is defined as having average annual gross receipts of $50 million or less for the three preceding tax years.
S corporation shareholders and partners in partnerships should look into whether they qualify as a small business in anticipation of using the research credit against their AMT.
If this looks like it may apply to you, you might consider adjusting quarterly estimates on wage withholdings to take advantage of using the credit sooner. Obviously, each tax case is different, and the new laws must be applied to each taxpayer’s specific situation.
If your facility meets the new eligibility requirements, and you are not taking advantage of this tax credit, you are effectively “leaving money on the table.” Either way, it would be a shame to not take advantage of such a benefit.
If you are a manufacturer and want to take advantage of this tax credit and potentially offset your AMT, please contact Angelo here. In addition, to learn more about SC&H Group’s Tax Services team, click here.