Tax Savings for Start-Ups and Small Businesses: R&D Credit Can Now Offset Payroll Tax
This is Part 1 of a 2-part series. Watch for Part 2, coming soon!
The 2015 Protecting Americans from Tax Hikes (“PATH”) Act included various changes to the Research and Development credit (“R&D Credit”) mostly beneficial for start-ups and small businesses.
PATH enables a qualified small business to elect to claim a certain amount of its R&D credit as a payroll tax credit against its employer portion of FICA liability, rather than against its income tax liability.
A qualified small business for this purpose is defined as a corporation, partnership, LLC or individual that, with respect to any taxable year:
- has gross receipts of less than $5M
- did not have gross receipts for any taxable year preceding the 5-tax-year period ending with the tax year
In other words, in order for a company to qualify to utilize the payroll tax offset in 2017, the company must not have more than $5M of gross receipts in 2016. It must also not have had any gross receipts in tax years prior to 2012. The definition of gross receipts is not clearly defined within the section, but many interpretations point to the following guidance: Gross receipts include all sales (net of returns and allowances), service income, interest, dividends, rents and royalties, as well as any income from incidental or outside sources.
The amount of the credit is limited to the lesser of $250,000 per year or the amount of the R&D credit computed on the taxpayer’s income tax return. Any credit that exceeds the amount of the taxpayers FICA tax liability in a given quarter may be carried forward to future quarters.
Process for Claiming the Payroll Tax Offset
- Compute the R&D credit on the 2016 or subsequent income tax return on Form 6765.
- Complete Form 8974, which is a new form, to report the credits elected to offset FICA tax.
- File payroll Form 941 with Form 8974 attached for each quarter that there is an offset.
A taxpayer may only claim the election for 5 years for a maximum credit of $1.25 million. Any election to apply the R&D credit to offset payroll tax cannot be revoked without the consent of the IRS.
In summary, these changes afford small businesses and start-ups an excellent opportunity to realize the tax benefit of their R&D credits, whereas in the past they may have had to wait years to reach profitability or even been precluded from using their credits due to various limitations.
During the current tax filing season, consideration should be given to the preparation of elections, calculation of the R&D credit and timely filing of the returns in order to enable taxpayers to obtain the largest possible benefit from the new PATH Act rules.