On December 18, 2015, the PATH, or Protecting Americans from Tax Hikes Act was signed into law by President Obama. This act made several ‘temporary’ tax credits permanent, including the Research Tax Credit.
Who Can Get a Research Tax Credit?
As with all tax breaks, there is a lot of fine print regarding this tax credit. First you cannot claim more than 16% of average annual receipts for the past four years. Second, the credit will only cover 20% of qualified research expenses. Nonetheless, this is a great opportunity for small business owners who wish to perform product research because it can be claimed as a credit against your alternative tax liability beginning in 2016. In addition, a start up can claim up to $250,000 in research expenses against its tax liability.
What Expenditures Qualify?
In order to qualify for this research credit, your expenses must be considered a “research and experimentation expenditure” by Section 174. This section of the tax code includes wages and supplies for research, defined as experimentation relating to a new or improved product or aspect of a product. Qualified expenses include time sharing costs of computers and other technologies, and 65% of expenses to hire contractors.
Keep in mind that you cannot claim an expense twice. If you are taking a research tax credit, you cannot use the same expenses as a Section 174 deduction.
Incentive to Innovate
This tax credit will likely inspire many small business owners to research new services and products, because the overhead cost will be significantly reduced by this tax credit. Even smaller businesses can afford to dabble in science to improve their product. That is a huge benefit for businesses struggling to break into competitive fields.
Until the PATH Act, Congress had an annual tradition of deciding in December to extend the tax credit for another year. This created instability among individuals and businesses planning to do research, as these projects require planning years ahead. Now, however, people can plan research well into the future and be assured of the tax breaks associated with research costs.
