Since 1981, Internal Revenue Code (IRC) §41, Credit for Increasing Research Activities, known as the Research & Development (R&D) tax credit, has provided companies in such sectors as manufacturing, aerospace, pharmaceutical, and technology more than $10 billion in tax savings annually.¹

However, until the end of 2015, the R&D credit was temporary and often only enacted for two years at a time. It would periodically expire and go unaddressed for up to 12 months until Congress would extend it. These extensions often made it effective retroactively, covering the year in limbo and possibly the following year. The constant expirations and long periods of uncertainty over its renewal made it unreliable.

After realizing that the uncertainty of the credit reduced the incentive to perform research, Congress enacted the Protecting Americans from Tax Hikes (PATH) Act of 2015 to make the R&D tax credit a stable source of tax savings beneficial for both small and large companies in multiple industries, including construction.

Permanency Brings Big Benefits

Contractors employ highly technical civil, mechanical, electrical, and structural engineers to develop products and processes – activities that are often eligible for R&D credit. Since these activities support the construction of various projects (e.g., dams, bridges, commercial buildings, mechanical systems, electrical systems, and foundation systems), now is a great time to take advantage of the credit.

In addition to the general benefit of certainty, the extension has several substantial advantages:

Consistent Financial Reporting

One of the most significant benefits for contractors is that they can now consistently claim the R&D credit on their quarterly financial statements.

Previously, companies could not record the tax benefits in their financial statements if the credit had expired, which could cause disparities on yearly or quarterly statements. They could only include the R&D credit at the end of the year or during the first quarter of the next year after Congress had extended it and made it retroactive, if it was extended at all.

Companies can now consistently report the benefits throughout the year and do not have to make higher estimated tax payments and report less income during those periods.

AMT Limit Lifted for Small Businesses

Another PATH Act change makes it easier for smaller companies to realize R&D benefits regarding potential alternative minimum tax (AMT) liability.

Prior to the PATH Act, the R&D credit could not reduce a company’s tax liability to less than the computed AMT tax liability. The new PATH Act provision removes this limit and enables the R&D credit generated by eligible companies to be used against the AMT liability – a significant change for small businesses.

For example, suppose Company A has regular taxable income of $250,000 and regular tax liability of $85,000. In comparison, under the AMT calculation, which adds certain deductions back into its tax liability, Company A has $600,000 in taxable income that results in a tentative AMT liability of $120,000. Ordinarily, Company A would have to pay the $120,000, but under the new rules, the R&D credit can reduce that amount.

For purposes of the AMT limitation exception, the IRC defines small businesses as any privately held corporation, partnership, or sole-proprietorship whose average annual gross receipts for the previous three-year period are $50 million or less.