The alternative minimum tax is a little-known parallel tax system that ensures that qualifying individuals pay a certain amount of taxes regardless of how many credits, deductions, or tax breaks the filer may claim for themselves,
The I.R.S. has a system of income thresholds that determine who qualifies to pay the alternative minimum tax or the AMT. And depending on your income, business interests, and other qualifying factors, the AMT rate for qualifying filers can be as high as 28%.
And the exemption ceiling rate for single and joint filers can be as high as hundreds of thousands and millions of dollars. So, if you qualify for the AMT rate and tax bracket, then you can end up owing the United States government a lot of money every tax season.
However, tax filers, businesses, and business entities that qualify for the AMT rate can potentially find some tax relief via research and development tax credits. AMT liabilities can be reduced with the strategic application of Research and Development tax credits.
But before we can explain how R&D tax credits can significantly offset AMT rates and liabilities, we must first discuss the Tax Cuts and Jobs Act of December 2017.
The Tax Cuts and Jobs Act was ratified by then-President Donald Trump in December 2017. And the Tax Cuts and Jobs Act was radical for its time because of how exhaustively it changed and updated various parameters of the American tax code and accompanying laws.
The Tax Cuts and Jobs Act system practically doubled standard deduction rates, appreciably reduced standard income tax rates, created new limitations for itemized deductions, raised the estate tax exclusion to over $11.4 million in qualifying circumstances, and created a host of other tax code related changes.
And when it came to the Alternative Minimum Tax, the Tax Cuts and Jobs Act included various provisions that relatively lessened the impact of the AMT.
The TCJA increased the income requirements where AMT exemptions can phase out, created higher ceilings for AMT exemptions, and significantly scaled back the preference items requisites for the largest AMT rates.
And as a result of these Tax Cuts and Jobs Act provisions, the total number of Americans who qualified for the AMT rate decreased from over 5 million in 2017 to just about 200,000 in 2018.
Still, that means that over 200,000 Americans and business institutions have a lot to worry about when it comes to AMT rates.
So, how can one offset AMT rates with research and development tax credits? And what exactly are research and development tax credits?
Let’s start by explaining what alternative minimum taxes are first.
Contact Parachor today. We will help your business find every applicable qualifying tax credit and break.
Related: Form 8974: Everything You Want to Know.
What is AMT?
As described by the I.R.S., alternative minimum taxes are a set of alternative taxes, calculated via differing tax rules, designed to ensure that qualifying filers pay a minimum income tax amount.
Qualifying AMT filers are limited when it comes to standard tax breaks, so their tax bills are inevitably higher.
The AMT legislative tax code is a system that runs parallel to the traditional American tax system. However, the AMT code has a singularly different tax rate structure.
And the AMT code is notorious for eliminating the most common tax breaks that traditional tax filers take for granted. After all, the AMT code only has two tax rates, 26%, and 28%.
For context, consider that the traditional American tax code system has seven income tax brackets: 10%, 12%, 22%, 24%,32%, 35%, and 37%.
And that means that the 200,000 Americans who qualify for the AMT rate don’t have a lot of wiggle room if their AMT calculation doesn’t work in their favor.
So, how is the AMT calculated anyway?
How AMT is Calculated
If your tax liability under the AMT code rules is higher than your traditional income tax liabilities under standard federal income tax rules, then you would pay whichever amount is highest.
Another way to think of it is to think of the AMT liability is that it’s triggered when the income thresholds of qualifying filers are above the annual AMT exemption amount.
Almost all AMT filers have higher incomes and net worth values than traditional tax system filers. So, AMT filers typically have to calculate their income tax liabilities twice under the AMT and traditional federal tax system.
Then, the AMT filer will pay whatever the higher amount is owed.
To calculate your AMT liability, you need to use I.R.S. Form 6251 to accurately calculate your taxable income sans any and all tax breaks, exclusions, and deductions as per AMT calculation metrics. (More on that later)
The AMT exemption amount in 2021 for single filers is $73,600 and $114,600 for joint filers.
And the AMT exemption phases out at $535,600 and $1,047,200 for single and joint filers, respectively.
You subtract the applicable exemption amount after you calculate the AMT amount of your taxable income.
Then multiply that amount by your applicable AMT rate, which can be 26% or 28%.
And again, your applicable AMT rate depends on your income.
If you qualify for such, you may be able to subtract the AMT foreign tax credit as well. The amount leftover is your applicable income tax rate under the AMT.
Now that we understand all of this, how do Research and Development tax credits help offset tax liability for AMT filers?
Research and Development Tax Credits
Research and Development tax credits are tax breaks afforded to taxpayers and businesses that develop, design, or improve upon processes, techniques, software, or consumer products.
And R&D tax credits can be strategically applied to offset AMT liabilities so long as you are an Eligible Small Business (“ESB”). Any business is an ESB so long as they meet the following requirements:
- Is a corporation whose stock isn’t publicly traded;
- A partnership; or
- A sole proprietorship.
Also, the average annual gross receipts of the corporation, partnership, or sole proprietorship for the 3-tax-year period preceding the tax year of the credit can’t exceed $50 million. What this means is A LOT of small to mid-size businesses can use the R&D credit to offset AMT.
Additionally, qualifying AMT filers can leverage amounts up to $250,000 of R&D tax credits against their annual payroll taxes. Using R&D tax credits to offset AMT is a complicated process that requires the help of tax experts. Don’t try to accomplish it on your own.
Contact Parachor today to help your business claim every qualifying tax credit.