Understanding the R&D Tax Credit Carryforward Period

R&D Tax Credit

small business

Deborah Roth, CPA
August 14, 2023

The R&D Tax Credit Carryforward Period refers to the duration during which unused portions of research tax credits can be applied to offset future tax liabilities. This provision is often overlooked by many taxpayers who are eligible for R&D Tax Credits. In most cases, companies that have qualified research expenses but lack current income can carry forward these credits to offset taxes on forthcoming profits. The carryforward period allows credits to remain applicable for up to 20 years. Additionally, the option to carry back credits for the previous year is also available.

Adapting to AMT Offset

Before the enactment of the PATH Act, limitations arising from the Alternative Minimum Tax (AMT) hindered companies from fully realizing the benefits of their R&D Tax Credits. The PATH Act of 2015 marked a significant shift in this landscape. It allowed small businesses to offset AMT using the research credit for tax years beginning after December 31, 2015. Nevertheless, any credits carried forward from the years preceding 2016 remained subject to AMT limitations. The Tax Cut and Jobs Act (TCJA) subsequently eliminated AMT for C-corporations, enhancing the scope for using past, present, and future research tax credits to reduce tax burdens.

The 25/25 Limitation

A steadfast rule, known as the "25/25 limitation," dictates that taxpayers with regular tax liabilities exceeding $25,000 cannot offset more than 75% of their tax liability using the credit. This rule, defined in Section 38(c)(1), ensures a balanced approach to credit utilization.

A Case in Point

Illustrating the concept, consider a start-up software company with an R&D Tax Credit eligibility. In its initial three years (2016-2019), the company reported losses. Upon turning profitable in 2020, it claimed R&D credits for the current and preceding three years. While the company had $100,000 in research tax credits, its federal tax liability stood at $120,000. However, due to the 25/25 limitation, only $90,000 of the credit could be applied, resulting in a $10,000 carryforward for the next year.

TCJA's Impact on NOL Carryforwards

The TCJA introduced an amendment to Sec. 172(a) for tax years commencing after December 31, 2017. This amendment limited the use of net operating losses (NOLs) to 80% of taxable income. This constraint prompted some taxpayers to seek alternative tax-saving opportunities, including the R&D Tax Credit.

Under the CARES Act, NOLs from tax years starting after December 31, 2017, and before January 1, 2021, could be carried back up to five preceding tax years. Furthermore, the 80% limitation was temporarily removed by the CARES Act, reenacted for tax years beginning after 2020.

State-Level Carryforward Regulations

Many states also permit the carryforward of unused R&D Tax Credits. These state guidelines mirror the federal 20-year carryforward period, while some states set their own limits, ranging from none to indefinite. For instance, California currently has no limitation on the carryforward period.

Our Assistance

Now is a pivotal moment to reevaluate past, present, and future R&D endeavors to harness the potential of the R&D Tax Credit, regardless of industry. If your company engages in qualifying activities, don't miss out on potential tax savings. GOAT.tax is poised to assist you in identifying essential tax-saving opportunities that can be reinvested in your business to propel your next significant undertaking.

(This article offers a concise overview of intricate regulations. To gain tailored insights into how these rules apply to your specific circumstances, it's advisable to consult a professional tax advisor.)

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