For the tax year(s) in which the R&D credit was claimed, the taxpayer must deduct the amount of the credit from their deductible expenses pursuant to IRC Section 280C(c)(1). To put it another way, Section 280C(c)(1) requires taxpayers to raise their taxable income by the credit’s amount.
By making an election in accordance with IRC Section 280C(c)(3), the taxpayer has the choice to prevent the reduction of their R&D expenses. The taxpayer effectively reduces their R&D credit amount by the amount of the top corporation tax rate, which is presently 21%, by selecting this choice. Without subtracting the costs incurred to seek the credit, they might claim the credit’s after-tax value.
If the taxpayer is in the highest income bracket, making this choice may have a similar net tax benefit to not making it. Additionally, it is simpler to apply on the tax return. However, the choice must be made on a return that was initially filed (including any extensions). Therefore, persons who update their tax returns to claim the credit are not eligible for this election.
R&D Credit Treatment as Taxable Income
If a taxpayer cannot elect the Reduced Credit under IRC Section 280C(c)(3) or elects not to do so, they must increase their taxable income by making an adjustment to Schedule M-3 or Schedule M-1. Tax preparers and CPAs who may be unfamiliar with the R&D tax credit’s workings as they pertain to the tax return may run into problems when determining how to classify the credit as taxable income.
Schedule M-1: Taxpayers who have combined receipts and assets totaling at least $250,000 must file Schedule M-1. This adjustment to taxable income is often reported on line 4 of Schedule M-1 for partnerships and S-corporations. This is often modified for corporations on line 5 of Schedule M-1. A statement itemizing the sort of income, the amount, and a description stating the income name for book purposes should be attached by tax preparers.
Schedule M-3: Taxpayers with total assets of $10 million or more must file Schedule M-3. Partnerships and S-corporations must modify the R&D expenses listed on Schedule M-3 line 29 as required by Section 174. These modifications are performed on line 35 of Schedule M-3 for corporations.
Businesses who choose 280C can also lower their state taxable income since the federal income tax rate is often used as the starting point for state R&D calculations.