The 2015 PATH Act retroactively and permanently extended the research credit IRC Sec. 41(h)

There are added incentives for small businesses: For credits determined for tax years that begin after December 31, 2015, an eligible small business ($50 million or less of gross receipts) may claim the credit against its alternative minimum tax (AMT) liability [ IRC Sec. 38(c)(4)(B)(ii) ].

For tax years that begin after December 31, 2015, a qualified small business may elect to claim a portion of its research credit as a payroll tax credit against its employer FICA tax liability, rather than against its income tax liability [ IRC Secs. 41(h) and 3111(f) ]. A qualified small business is one that, in the case of a corporation or partnership with respect to any tax year, has gross receipts [as determined under the rules of IRC Sec. 448(c)(3) , without regard to IRC Sec. 448(c)(3)(A) ] of less than $5 million, and did not have gross receipts for any tax year preceding the five tax-year period ending with the tax year [ IRC Sec. 41(h)(3)(A)(i) ].

The payroll tax credit portion is equal to the least of-

    a. an amount specified by the taxpayer that does not exceed $250,000,

    b. the research credit determined for the tax year, or

    c. in the case of a qualified small business other than a partnership or S corporation, the amount of the business credit carryforward under IRC Sec. 39 from the tax year (determined   before the application of IRC Sec. 41(h) to the tax year) [ IRC Sec. 41(h)(2) ].

The election cannot be made for a tax year if the taxpayer has made such an election for five or more preceding tax years [ IRC Sec. 41(h)(4)(B)(ii) ].

What about the Payroll Tax Portion of the credit:

The payroll tax portion of the research credit is allowed as a credit against the qualified small business's OASDI tax liability for the first calendar quarter beginning after the date on which it files its income tax or information return for the tax year. The credit cannot exceed the OASDI tax liability for a calendar quarter on the wages paid with respect to all employees of the qualified small business. If the payroll tax portion of the credit exceeds the qualified small business's OASDI tax liability for a calendar quarter, the excess is allowed as a credit against the OASDI liability for the following calendar quarter [ IRC Sec. 3111(f) ]. The credit allowed against employer FICA cannot be taken into account for purposes of determining the amount allowable as a payroll tax deduction [ IRC Sec. 3111(f)(4) ].

Businesses often mistakenly assume that they are ineligible for the research credit (RC) credit or underestimate the expenditures that count for the credit. Taxpayers improving their product, as well as improving the process to make their product, may be eligible for the credit . The RC can be claimed for "qualified research expenditures" (QREs) conducted as part of a taxpayer's trade or business. QREs are the sum of contract research expenses and in-house expenses [ IRC Sec. 41(b)(1) and Reg. 1.41-4 ].

In-house research expenses include:

     a.Wages paid to an employee engaged in qualified research or in the direct supervision (first-line management) or direct support of qualified research (excluding wages to which the work opportunity credit applies).

     b.Amounts paid for supplies (any tangible property other than land or depreciable property) used to conduct qualified research.

     c.Amounts paid to another person for the right to use computers in the conduct of qualified research.

Qualified research is research and development in the experimental or laboratory sense that meets the following tests [ IRC Sec. 41(d) ]:

     a.The expenditures qualify as expenses under IRC Sec. 174 .

     b.The research must be undertaken to discover information that is technological in nature; i.e., it must rely on the principles of the physical, biological, engineering, or computer sciences.

     c.Substantially all of the research must contain elements of a process of experimentation relating to a new or improved function, performance, reliability, or quality.

     d.The application of the research is intended to be useful in the development of a new or improved business component.

The issue of what activities or expenses qualify for the RC has been controversial. According to IRC Sec. 41(d)(4) , the RC does not apply to (a) research conducted after the start of commercial production of a "business component;" (b) research to adapt an existing business component to a specific customer's needs or requirements; (c) research related to the duplication of an existing business component; and (d) surveys and studies related to data collection, market research, production efficiency, quality control, and managerial techniques. Some areas of controversy have been the RC's application to internal-use software, the eligibility of research aimed at achieving significant cost reductions, and a refocusing of the RC to address projects with a significant potential for producing substantial economic benefits (e.g., breakthroughs that create new product categories or innovative enhancements to existing products).

The 2012 American Taxpayer Relief Act modified, for tax years beginning after December 31, 2011, the credit allocation rules among members of a controlled group of corporations, and provided credit calculation rules when a major portion of a business or a separate business unit is acquired or disposed of [ IRC Sec. 41(f) ]. The IRS issued guidance in 2013 describing the methodology for allocating the RC among members of controlled groups ( IRS Notice 2013-20 ).