by John Deininger and Tom WindramRSM US LLP is an IMA Member
As the impacts of the Tax Cuts and Jobs Act (TCJA) become more apparent during the 2018 filing season, the interplay between the tax rate for individual owners of a pass-through compared to the new corporate rate shows that pass-through entities should ensure they make a section 280C(c)(3) reduced credit election when claiming the research credit.
Section 280C requires any taxpayer claiming the research credit to also reduce its section 174 research expense deduction or research expense chargeable to its capital account, depending on the taxpayer’s treatment, by an amount equal to the claimed section 41 credit.
Section 280C(c)(3) provides taxpayers the ability to elect a reduced research credit percentage in lieu of the section 174 expense adjustment. In the past, making the election has generally been an issue of convenience for the taxpayers claiming the credit. Simply checking box on line 17 or 33 of Form 6765 and reducing the gross credit by the amount as required by the form was substantially simpler than adding back the gross credit amount into the taxpayer’s gross income.
The section 280C(c)(3) reduced credit election must be made on a timely filed original return. With the substantial reduction to the corporate tax rate starting with tax years beginning after Dec. 31. 2017, making a timely section 280C(c)(3) election carries even greater significance. Section 280C(c)(3)(B) provides that the reduced credit is calculated by multiplying the credit by the maximum corporate tax rate. The election calculation uses the corporate rate regardless of the type of entity claiming the credit.
For the 2018 and current tax years the maximum corporate rate is 21 percent per section 11(b). Meanwhile, the maximum rate for an individual is 37 percent, or potentially 29.6 percent for an individual who is subject to section 199A. Any pass-through entity with individuals as owners that is able to claim the research credit should ensure that it effectively makes the section 280C(c)(3) election.
By making the section 280C(c)(3) election, the pass-through entity reduces its gross credit by 21 percent. A pass-through entity that fails to make the election, and therefore must add back the research credit into gross income, could potentially reduce the research credit by as much as 37 percent. That difference compared to the corporate rate used in the 280C election would result in an individual owner losing as much as 16 percent of the credit if a timely 280C(c)(3) election is not made.
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