Congress passed and the President signed a tax act in December. Here are some highlights that may benefit startup companies.
- R&D Credit made permanent. The research and development (“R&D”) credit of 20% of qualified research expenditures had expired for costs incurred after December 31, 2014. The new tax act (known as the Protecting Americans from Tax Hikes or the PATH Act) retroactively extends the credit for costs incurred after December 31, 2014. If your company filed a tax return for a fiscal year or a short year ending during 2015 and your company had qualifying R&D costs, consider filing an amended return to claim the credit on the qualifying expenses.
- R&D Credit applicable against AMT. An eligible small business (one with average annual gross receipts over the most recent three year period of not more than $50 million) may claim the R&D Credit against the alternative minimum tax (“AMT”). AMT is imposed when the alternative minimum tax [imposed at 20% for corporations and for individuals and other non-corporate taxpayers at 26% (for AMT net income not more than $175,000) or 28% (for AMT net income over $175,000) but computed without many deductions and credits], exceeds the regular tax. The regular tax is imposed at up to 39.6% for individuals and other non-corporate taxpayers and 35% for corporations.
- R&D Credit applicable against payroll tax. A qualified small business—meaning an entity having less than $5 million in gross receipts and which did not have taxable receipts in any year more than five years previous (meaning a startup that recently started to have sales income)—may claim some or all of the R&D Credit against the employer portion of FICA withholding. The amount of the R&D credit that may applied to reduce the business’s employment tax liability is limited to $250,000 per year. There are several further limitations on the use of the R&D credit against employment taxes, one of which applies to limit the use of the R&D credit against the entity’s employment tax liability, to the lowest of (a) the amount of the R&D credit elected for use against the employment tax liability, (b) the amount of the R&D credit for the year, or (c) the amount of the R&D credit that would otherwise go unused for the year.
Small Business Changes
- 1374 tax on built in gain for S corporations only applies for 5 years now. When a C corporation elects S corporation status or when an S corporation acquires assets of a C corporation in a tax-free transaction, it must determine its subchapter C built in gain—the excess of (i) the value of the assets of the C corporation at the time that the corporation’s subchapter S election becomes effective or the time that the acquisition of the assets of the C corporation by the S corporation is effective over (ii) the tax basis of those assets. If the S corporation sells those assets within five years of the date of the subchapter S election or the date of acquisition of those assets, the S corporation is taxable at the corporate level on the subchapter C built in gain. That five year period was reduced from ten years. A C corporation now only has to wait five years after the effective date of its subchapter S election before it becomes a completely pass-through entity.
- Section 1202 100% exclusion now permanent. Section 1202 allows a complete exclusion from tax on gain from the sale of stock of a qualified small business corporation. This may be a very attractive provision for startup companies that engage in a qualified business, in general any business other than personal services, real estate, farming or hotel management. Any C corporation engaged in a qualified business with aggregate gross assets having a value of $50 million or less may be a qualified small business. If an investor (other than a C corporation investor) holds the qualified small business stock for five years, any gain on the sale is permanently excluded from federal income taxation. This had been the treatment since 2010. This provision was annually extended. The PATH act made the 100% exclusion permanent. Incidentally, if qualified small business stock is disposed of after being held for six months but less than five years, the gain may be deferred if the amount realized (not just the gain) is rolled into new qualified small business stock within 60 days of the first sale. That latter rule was unaffected by the PATH act.
Section 179 Expensing Changes
- Section 179 allows a business to deduct up to $500,000 in qualified capital expenditures that otherwise would have to be capitalized and depreciated over the useful life of the assets purchased. The PATH act provides that the $500,000 expensing limitation will now be indexed for inflation. The ability to expense the cost of capital assets is reduced for each dollar over $2 million that capital expenditures represent, so at $2.5 million in capital expenditures, the deduction is reduced to zero.
- Section 179 allows for expensing of the cost of computer software that might otherwise have to be depreciated or amortized. The computer software would have to satisfy the other requirements of Section 179 for expensing capital expenditures.
- The right to revoke the 179 election without IRS consent has been made permanent by the PATH act.
- The PATH act made permanent the right to expense up to $500,000 (commencing in 2016) of the cost of qualified real property, which is defined as qualified restaurant property or qualified retail improvement property that was (1) of a character subject to the allowance for depreciation, (2) acquired for use in the active conduct of a trade or business and (2) not excluded under any of the rules that exclude other types of property from being “section 179 property.” The cap on the cost of qualified real property that could be expensed was $250,000 for 2015.
Section 181 of the Internal Revenue Code allows expensing of up to $15 million ($20 million for expenses incurred in certain designated distress and low income communities) in film and TV production costs as long as 75% of the compensation costs for actors, directors, production personnel and producers were for services performed in the U.S. Section 181 was supposed to sunset for production costs incurred after 2015, but the PATH act extended the eligibility for the Section 181 deduction for production costs.
Michael Shaff joined the firm in 2011 as Of Counsel. He is chairperson of the Tax Practice Group. Michael specializes in all aspects of federal income taxation. Mr. Shaff has served as a trial attorney with the office of the Chief Counsel of the Internal Revenue Service for three years. Mr. Shaff is certified by the Board of Legal Specialization of the State Bar of California as a specialist in tax law. Mr. Shaff is a past chair of the Tax Section of the Orange County Bar Association. He is co-author of the “Real Estate Investment Trusts Handbook” published annually by West Group.
For more information about the PATH Act and the Tax & Estate Planning Practice at Stubbs Alderton & Markiles, LLP, contact Michael Shaff at