When it comes to claiming R&D tax credits, many taxpayers are unaware of the rules allowing them to carryforward the unused portion of their research tax credit. In most situations, a company that has qualifying research expenses but no income can carryforward the credit to offset tax liabilities on future profit. Any unused R&D credits will carry forward for up to 20 years. In addition to carryforwards, the research tax credit can also be carried back one year.
What is the R&D Tax Credit?
R&D tax credits, also known as the Research and Development credit, enable businesses to potentially reduce their federal income tax. Taxpayers might qualify for the credit if:
- They paid for (or incurred) qualified research expenses.
- The expenses have been for qualified research activities.
Considerations and Additional Factors Relating to the R&D Tax Credit Carryforward
There are a few factors affecting the rules of the carryforward, which include the AMT Offset, the 25/25 Limitation, TCJA Effects on NOL Carryforwards, and state-specific carryforward rules.
The Alternative Minimum Tax (AMT) Offset
Prior to the enactment of the PATH Act, taxpayers were unable to realize the full benefit of their R&D tax credits in a given year due to AMT restrictions. The AMT limitation prevented qualified companies from utilizing 100% of the tax credit; consequently, the excess R&D tax credits were carried forward.
The PATH Act 0f 2015 was one of the first initiatives to make significant changes in the relationship between AMT and the R&D Tax Credit. For tax years beginning after December 31, 2015, small businesses can offset AMT using the research credit against. However, any carryforwards from tax years prior to 2016 are still limited by AMT.
Fortunately, the Tax Cut and Jobs Act (TCJA) eliminated AMT for C-corporations providing these companies the opportunity to further reduce their tax bills using past, present, and future research tax credits.
25/25 Limitation
There is one rule in place that restricts taxpayers from offsetting a percentage of their tax liability, known as the 25/25 Limitation. The 25/25 Limitation restricts taxpayers with over $25,000 in regular tax liability from offsetting more than 75% of their tax liability using the credit (Sec. 38(c)(1)).
TCJA Effects on NOL Carryforwards
For all taxpayers, the TCJA amended Sec. 172(a) for any tax year beginning after Dec. 31, 2017, by adding a new limitation on the use of net operating losses (NOLs) that restricts their use to 80% of taxable income. The new 80% taxable income limitation may require some taxpayers to seek additional tax savings opportunities, such as the R&D tax credit.
Under the CARES Act, NOLs arising in tax years beginning after December 31, 2017, and before January 1, 2021 may be carried back to each of the five tax years preceding the tax year of such loss. In addition, the CARES Act also temporarily removes the 80% limitation, reinstating it for tax year beginning after 2020.
State R&D Carryforward Rules
Many states allow unused credit to be carried forward. Some mirror the federal carryforward guidelines of 20 years and others range from zero to eternity. In California, there is actually no limit on how far forward you can apply the R&D tax credit carryforward.
R&D Tax Credit Carryforward Case Study
Let’s say there is a blockchain company that is eligible for the R&D tax credit. The company experienced losses from 2016 through 2019, a total of 3 years. Then by 2020, the blockchain company is now profitable. They choose to claim the R&D tax credits for 2020 as well as 2016 through 2019. This creates a carryforward that they plan to use in 2020.
The blockchain company calculates a total of $100,000 in research tax credits and has a federal tax liability of $120,000. But due to the 25/25 limitation, it can only apply $90,000 of the credit to offset its tax liability. The remaining $10,000 will be carried forward to the subsequent year.
How We Can Help
GOAT.tax is powered by Source Advisors, a leading tax consulting firm providing R&D tax credits for almost 4 decades. Founded on the basic principle that the R&D tax credit should be available to companies of all sizes without fees burdening the benefit, the GOAT.tax automated software platform is backed by 305+ years of collective R&D tax credit experience. This is what sets us apart from any other platform. Our people and our experience.
Now is a good time to reexamine prior, current, and future R&D activities in order to take advantage of the R&D tax credit, regardless of industry. If you think your company might be performing work that qualifies, don’t let the potential tax savings go unclaimed. GOAT.tax can help you uncover vital tax savings to reinvest in your business and fuel your next big project.
Automated Software vs. Traditional R&D Tax Credit Consulting
GOAT.tax was created to educate businesses on the R&D tax credit and help those who qualify successfully claim it on their own. Our nationwide team has over 350 years of collective R&D tax credit experience, and our mission is to take the guesswork out of this credit so you can focus on your core business.
The Three Types of Research and Development
Businesses should consider claiming the Research and Development tax credit for various reasons, but eligibility must be determined and three types of R&D align with the business's nature.
Common Challenges When Claiming R&D Tax Credits
Although claiming this credit can offer considerable benefits for companies engaged in R&D efforts, the process can be challenging.