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R&D credit article for FEI Silicon Valley News Brief
New R&D credit gives a boost to start-ups and Tech industry
A new and improved research and development (R&D) tax credit headlined a $680 billion tax cut package
enacted in December, and the provision appears almost tailor-made for Silicon Valley. The Protecting
Americans from Tax Hikes Act of 2015 (PATH Act) not only makes the R&D credit permanent for the first
time in its more than 30-year history, but also enhances it in ways that make it even more valuable for startups and the Tech industry.
The R&D credit was first enacted as a temporary incentive in 1981 as a response to R&D incentives being
offered by various European governments. Since then it has been extended 16 times, even suffering a one
year lapse in the 1990’s. It is undoubtedly the most important tax incentive for many research-intensive
sectors like IT, but its temporary nature has long undermined its effectiveness. Congress often assumed that it
could be extended retroactively without any loss in its incentive affect. This is not the case.
A Grant Thornton survey of financial executives in 2015 found that over half of businesses who used the
R&D credit and other temporary incentives assumed the provisions would not be extended until they were
actually reinstated. Another 16.6% of executives assumed significant risk that the provision would not be
available. Because the credit often expired before it was extended retroactively, many businesses wouldn’t
count on it, sapping the incentive for additional research and creating a large barrier to growth.
Now, for the first time in its history, the R&D credit is a permanent part of the Internal Revenue Code. The
change should give a boost to the Tech industry, especially as recent guidance and case law has made the
credit even more valuable to IT companies. The Tax Court recently rejected two common IRS arguments
against R&D claims affecting Tech companies and startups. The court ruled in Suder v. Commissioner (T.C.
Memo 2014-201) that certain executive employee wages can be allocated to research and that “routine”
research that doesn’t “reinvent the wheel” can still qualify for the credit. These changes may be especially
important to startups as executives are often directly involved in research.
The IRS has also recently proposed new rules that expand the kinds of internal use software that can qualify
for the credit. Your internal use software may qualify for the credit if it meets a higher threshold for
innovation, falls into a new dual-use software safe harbor, or allows your company to interact with third
parties. The change is an immediate boon for the IT sector, and companies can generally rely on the
proposed rules now.
Even more importantly, the PATH Act includes important enhancements that make the credit more
attractive for Silicon Valley start-ups. The R&D credit has historically provided little incentive for start-up
businesses because it provides no value until the company is turning a profit. Beginning in 2016, the credit is
now partially refundable against payroll taxes. Businesses with less than $5 million in annual gross receipt over
the last five years, and no gross receipts beyond that five-year window, can claim up to $250,000 in R&D
credit against payroll taxes. This change will provide a valuable new benefit for startups that otherwise might
not have even pursued claims until long after they became profitable.
Larger companies that are starting to become profitable may also be able to take advantage of the credit for
the first time under a separate change. Many companies starting to turn a profit often have net operating
losses from past years that push them into the alternative minimum tax (AMT), which limits their ability to
benefit from the R&D credit. Beginning in 2016, privately held businesses with no more than $50 million in
annual gross receipts can now claim the R&D credit against the AMT.
Both large and small companies in the Tech industry will benefit from the Path Act, but the provisions
should prove especially valuable for Silicon Valley startups that previously may not consider it worth their
while to pursue and R&D credit claim. The R&D credit can often apply broadly to many kinds of research,
and now provides a new refundable source of funding.
Donald Corbett | Partner, Regional Tax Leader-West
Grant Thornton LLP
150 Almaden Blvd., Suite 600 | San Jose, CA | 95113 | UNITED STATES
T 408 216 8500
E [email protected] | W www.grantthornton.com