September 6, 2018
by Tracy Lustyan for alliantgroup
Published in Software Magazine
Tax season has come and gone, but for software and tech companies, next year’s season is when these businesses will feel the most substantial impact of the recent tax reform bill. With many of the most important provisions from the legislation set to take effect in tax year 2018—meaning next tax season—now is the time for executives to review the new opportunities that exists for both big tech and startups.
Here we highlight a few segments of the bill and a breakdown of its anticipated impact on software and tech companies.
Reduced Rates for Corporations
The new law slashes the corporate tax rate down from 35 to 21 percent and completely eliminates the corporate Alternative Minimum Tax (AMT). Both modifications are permanent.
Both provisions are obviously great news for big-time tech companies, with the reduced rates putting the Amazons, Apples, and Googles of the world in an even better position to compete on a global scale. The reduction in the corporate rate and the elimination of corporate AMT—the latter allowing C corporations to use credits and incentives they were effectively barred from to further reduce their tax liability—will pump millions back into these corporations, offering substantial opportunities for growth.
In addition to lowering the corporate tax rate, the new legislation offers tax relief for pass-throughs by reducing individual tax rates and through an up to 20 percent deduction on qualified business income (QBI). The new law maintains the seven bracket tax structure, but with the rates for several tax brackets dropping and a new top rate of 37 percent.
Additionally, the law curbs who is hit by AMT on the individual side by raising the income exemption levels—$70,300 for single filers, $109,400 for joint filers, and the phase out threshold of $500,000 for single filers and $1 million for joint filers.
Given their likelihood in being organized as pass-throughs and the across the board reduction in individual tax rates, these are the modifications that are set to benefit startups and small- and mid-size technology firms. However, it should be noted that with regard to the deduction for QBI, a number of limitations can impact the deduction, key amongst them being the limitation based on W-2 wages.
The bottom line—while C corps receive the greatest windfall from the bill, several of these modifications are set to substantially benefit small- and mid-size technology firms and startups.
In addition to the above domestic taxation changes, the new law dramatically overhauls the international tax system for U.S. multinationals, moving from a worldwide tax system to a quasi-territorial system. The bill implements a one-time repatriation tax on multinationals bringing back their overseas profits—15.5 percent on earnings held in cash and cash equivalent assets—stocks, liquid assets, etc.—and eight percent for earnings attributed to non-cash assets—real estate, other hard foreign assets, as opposed to being taxed at the 21 percent corporate rate.
The legislation also includes a 10.5 percent tax on future foreign profits.
This is a major victory for large multinational tech companies. The obvious intent of the international tax law changes is to incentivize multinationals to bring their overseas profits back to the U.S. By offering a one-time repatriation holiday, multinational tech companies have been given a tremendous opportunity to reinvest here in the U.S., providing these companies the chance to improve their products and services, hire new professionals or raise employee wages.
R&D Tax Credit
One of the single most valuable business incentives, the R&D tax credit remains in place for the benefit of software and technology companies, from established multinationals to small and mid-size technology firms. Additionally, the elimination of corporate AMT and the curbing of the number of pass-throughs subject to individual AMT has opened the flood gates on the amount of companies able to utilize the credit.
Furthermore, federal R&D tax credits carry-back one year and forward 20 years, and the elimination of AMT will allow credits previously limited to AMT to carry-forward into 2018 and 2019. At a minimum, C corporations will have three years’ worth of R&D tax credits that can now be used against the new 21 percent corporate rate.
The software and tech industry as a whole.
The R&D tax credit is designed to reward companies for technical problem solving—be it finding ways to create bold and new innovative products or to enhance existing ones. The everyday design, implementation, and testing that goes into a new product launch is what traditionally makes software and tech companies the best candidates for the credit. Now, considering the elimination of corporate AMT and the loosening of individual AMT restrictions, the main hurdle preventing businesses from utilizing the credit in the past has been removed for many software and tech companies—big and small. As a result, additional software and technology companies will be able to utilize the credit.
Favorable Tax Modifications for Software and Technology
With across the board rate reductions, new favorable international tax laws and certain modifications impacting the R&D tax credit, software and technology companies are in a good position to benefit from the tax reform bill. With so many changes set to take effect next tax season, software and technology executives should consult with their tax advisors now to put their companies in the best strategic position moving forward.