Research tax credit limitations for partners and S corporation shareholders
TAX BLOG |
When determining the extent to which a shareholder in an S corporation or a partner in a partnership may benefit from the tax credit for qualified research activities performed by the pass-through entity, it is important to understand the special rule that applies to the pass-through of the research tax credit.
This rule limits the credit to the portion of tax that would apply to the individual owner’s taxable income that is derived from that person’s interest in the business entity that performed the research and generated the tax credit.
For example, assume Shareholder 1 has a 20 percent interest in S Corporation A and is taxed at the top marginal tax rate of 39.6 percent on income from the S corporation. The S Corporation A computes a research tax credit of $100,000 and passes through a credit of $20,000 on Shareholder 1’s Form K-1. S Corporation A also passes through $40,000 of taxable income to Shareholder A.
The research tax credit limitation for Shareholder A is then computed as $40,000 of taxable income multiplied by the marginal tax rate of 39.6 percent to compute a limitation of $15,840. Any credit in excess of the limitation cannot be used in the current year but may be carried back one year or carried forward for 20 years until it is fully utilized.
In the example above, the $20,000 total credit minus the $15,840 utilized credit would result in a $4,160 credit carryback or carryforward. Owners of S corporations and partnerships should ensure the taxable income limitation and any resulting carryforwards and carrybacks are taken into account when preparing their federal tax returns.