While the passage of this season’s extenders bill was widely anticipated before the end of 2015, it nevertheless contained some surprises for many observers.
For starters, a number of the extenders are now permanent, and won’t be up for renewal come next December. “That’s a big surprise to a lot of people out there,” said Tom Sanger, a partner in the Federal Credits and Incentives Group of Top 100 Firm Moss Adams. “We’ve been trying to have the R&D Credit made permanent for decades. Just a few months ago I was on a panel, and we asked who thinks the credit would be extended for one year, two years, or made permanent. About half thought it would be extended for one year, and half thought it would be extended for two years. Nobody thought it would be made permanent. Up to a day before passage, a lot were concerned about whether or not it could be passed. Permanency is huge for the R&D Credit, and for the other extenders that were made permanent.”
Two small-business friendly modifications to the R&D Credit in the Protecting Americans from Tax Hikes Act were somewhat of a surprise, Sanger added. The provision not only permanently extends the credit: Beginning in 2016 eligible small businesses — with $50 million or less in gross receipts — may claim the credit against their Alternative Minimum Tax liability, and the credit can be utilized by startups with $5 million against payroll taxes.
“That’s a very huge difference for smaller businesses,” Sanger said. “In many cases those companies were not able to use the federal credits because they were not profitable and therefore not taxable. Even those in the $20 to $30 million range had potential AMT hurdles so they could not use all or some of the credit, so this opens it up for them. For pure startups, with no revenues for a decade, they may have has $100 million in net operating losses with $30 million in R&D credits that are worthless to them. The fact that they can reduce their payroll tax by at least $250,000 a year for those with less than $5 million in revenue, and no revenue within the last five years, is a great benefit.”
“This legislation is a game changer for companies in all industries as it allows a tenfold increase in the number of small businesses that can utilize the R&D Credit by allowing the credit to be used against the Alternative Minimum Tax,” according to Dean Zerbe, former senior counsel to the U.S. Senate Finance Committee and alliantgroup national managing director. “Also, this is the first time start-up companies can benefit from the R&D Credit. Together these two changes will mean billions of dollars in tax savings for start-ups and small-business owners over the next few years and will encourage entrepreneurs to start innovative new businesses — the key to new jobs and economic growth.”
These provisions have been proposed in the past, but have never “stuck” to the final extender legislation, according to Sanger. “The fact that these two provisions actually stuck was a surprise,” he said. “In the past they were stripped out in the final legislation.”
One of the provisions that had been proposed did not stick, he noted. That was the proposed increase in the amount of the alternative simplified R&D Credit from 14 percent to 20 percent. “R&D advocates got permanency but the percentage stayed at 14 percent,” he said.
Previous extender bills typically passed easily with well over 90 percent of the vote, Sanger noted. “They had to throw enough benefits to enough groups into this one to get it to pass. The House vote was 318 to 109, while it passed the Senate with a 65-to-33 margin.”
Sanger said that he can see the alternative simplified credit being increased to 20 percent in the future. “They’ll keep improving it,” he said. Bonus depreciation, currently extended through 2019 for property acquired and placed in service during 2015 through 2019, will be tinkered with, according to Sanger. It is at 50 percent for property placed in service up to 2017, and phases down, with 40 percent in 2018, and 30 percent in 2019.
The fact that the Internal Revenue Code Section 179 expensing limitation is also now permanent is small-business friendly, Sanger indicated. “The dollar amounts are significant for both the 179 expensing limits and the R&D Credit,” he said.
Now that the Research & Development Credit is a permanent part of the Tax Code, companies can rely on it to decide where to invest in R&D, suggested Sanger. “In the past, it didn’t drive their behavior because they couldn’t project into the future,” he said. “Now they know they will get the credit if they invest in U.S.-based research.”
The provision allowing the R&D Credit against AMT if their gross receipts are below $50 million is potentially beneficial for pass-throughs such as partnerships and S corporations, according to Phillip Zaman, director in the National Tax Office of Top 100 Firm CBIZ. “That’s because the $50 million is applied at the ownership level,” he said.
The provision allowing the credit against payroll taxes for businesses with gross receipts of less than $5 million can be very useful for startups that have little or no taxable income that generates AMT, Zaman observed. “For a typical startup that doesn’t have any profit, there’s nothing to apply the R&D Credit against, so if it’s not paying tax, at a minimum the credit is deferred and eventually expires. But as long as it has employees, it’s paying payroll taxes, so it will get some immediate benefit.”
“A company can only take advantage of Section 179 to the extent it has taxable income; if it has losses it might not get the benefit. But a startup that’s not making money right away might not benefit from the 179 provision, it doesn’t need taxable income to take advantage of the 50 percent bonus depreciation. It would benefit more from that.”
The fact that there was a permanent extension to the 100 percent exclusion on the gain of qualified small-business stock is not something that startups or their owners would immediately benefit from, Zaman noted. “However, if the owner sells out within a few years, it’s a pretty important benefit. But to be a qualified small business, you have to be a C corporation,” he said. “A lot of small businesses don’t like to be C corporations because of the double taxation.”
“I’m shocked that we got these through in the first place, given all that we’ve been through in the past couple of years,” he said. “The fact that they accomplished the passage of these provisions heading into an election year is pretty amazing. The R&D Credit has been around forever and it gets extended every year, so most businesses assumed we were going to have it and went around with their normal routine.”
Kathleen King, managing director at Alvarez & Marsal Taxand, agreed. “What I found interesting about the PATH Act was that there’s something in it for everyone. The expansion and permanent extension of Section 179 is a big win for smaller businesses. In fact, it’s a win for many taxpayers. Congress went big this time.”
Some extenders were only picked up for one year. “They’ll have to pick some of those up next time,” she said. “Beyond that, there’s always talk of whether we need to think of reducing the overall corporate tax rate, to be competitive with the rest of the world. In order to effect that kind of change it will require a lot of other modifications throughout the Tax Code. Now that there’s been so much progress on the extenders, will it enable them to focus on changing the code to lower the rates? I’m sure that will be the goal of many in Congress this year.”
While everyone expected the extenders to get another year of life, there was always the chance that they wouldn’t, said Roger Harris, president of Padgett Business Services. “Now that you know that it’s there, you can plan for the first time with certainty. Any time that a small business can plan with certainty it’s better for them,” he said.
“What’s been extended covers a lot more things than what the average practitioner routinely deals with,” he said. “Though some of them are permanent, there are others that still have a time limit to them. Depending on what it means to you, I would caution that you check as to whether an extender is part of the permanently extended group, or has an expiration date. For example, if bonus depreciation is what you think of when we say ‘extenders,’ it’s not one of the permanent ones — it begins to change starting in 2018.”
“Section 179 is the biggest one for small businesses. It will probably touch all small businesses,” he explained. “The fact that the ones that most of us have to deal with on a year-to-year basis are now permanent is a real positive.”