April 4, 2018 / North America
With all the changes associated with the Tax Cuts and Jobs Act of 2017, one pleasant constant for taxpayers is the IRC 41 Credit for Increasing Research Activities, popularly known as the R&D Tax Credit. While taxpayers can continue to rely upon the R&D Tax Credit for savings, new features of the Internal Revenue Code present some interesting considerations.
280C(c)(3) Election – More Value for Pass-Through Business Owners
When claiming an R&D Tax Credit, a taxpayer generally must add the amount of the Credit back into taxable income via an M-1 Adjustment. However, IRC 280C(c)(3) provides taxpayers with the ability to take a “reduced” R&D Tax Credit and forego the M-1 add-back. While the 280C(c)(3) election (“280C election”) reduced the R&D Credit by 35 percent (Corporate Tax Rate), it typically proved an attractive option for many taxpayers. Individual taxpayers (i.e., owners of pass-through businesses) with effective federal income tax rates more than 35 percent often realized a larger overall benefit via the 280C election. Further, the 280C election would also negate some adverse state income tax effects of claiming the R&D Credit, as well as providing simplification for return preparers.
With the reduction in the Corporate Rate from 35 percent to 21 percent, the 280C(c)(3) “haircut” also drops to 21 percent. As a result, pass through business owners will see an even greater benefit by making this election. Since TCJA reduced the Corporate Rate far more than the top rate on individual income (39.6 percent to 37 percent), we now have a greater spread between those two rates, hence a greater 280C benefit. Even factoring in a maximum 199A deduction (also known as “the pass-through deduction”), the taxpayer significantly benefits. Consider the following example – ABC Company, organized as an S-Corporation with a single shareholder, generates $1,000,000 of taxable income in 2018, and also qualifies for a $100,000 R&D Credit based on its qualified expenses. As the following tables show, ABC Company’s shareholder realizes a lower federal income tax liability with the 280C election.