R&D credit payroll tax offset: A guide for qualified small businesses
- Qualified small businesses can use R&D credits to offset employer Social Security taxes, even without revenue.
- Eligibility requires under $5M gross receipts and no receipts before the prior five tax years.
- The R&D credit payroll offset is capped at $250,000 annually and must be elected on a timely filed return.
Research and development (R&D) tax credits have been used by taxpayers since the 1980s to generate income tax savings. However, the credit historically only benefited companies that were generating revenue.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 shifted the landscape expands the benefits to qualified small businesses — even if they lack income tax liability.
Here’s an overview of how small businesses can benefit from the R&D credit payroll tax offset:
What is the R&D credit payroll offset?
The R&D credit payroll offset provides companies with another means to use the R&D tax credit. With the payroll tax credit election, as long as the company has paid employees, they can use the R&D credit irrespective of whether or not they are generating revenue.
How the R&D credit payroll tax offset works
The PATH Act of 2015 allows qualified small businesses to use the federal R&D tax credit to offset the employer portion of the Social Security tax.
Note that the payroll tax election offsets the employer portion of the Social Security tax; it does not offset Medicare tax or the employee portion of Social Security tax.
How does the payroll offset differ from the standard R&D tax credit?
In simplest terms, $1 of R&D tax credit offsets $1 of income tax liability — quite a lucrative incentive. However, in the early years of development, some startup companies could not immediately benefit from claiming R&D credits because they were not generating revenue and thus not paying income tax.
The payroll offset changes that for eligible small businesses. Qualifying businesses can now use the credit by applying it to the employer portion of the Social Security tax, instead of income tax.
Who qualifies for the R&D credit payroll tax offset?
A taxpayer is considered a qualified small business and eligible for the payroll tax offset if they meet two qualifications. They must have:
1. Gross receipts less than $5 million in the current tax year.
2. No gross receipts for any tax year before the five tax years ending with the current tax year.
The gross receipts definition to determine eligibility includes total sales (net of returns and allowances), all amounts received for services, and any income from investments and incidentals. Included in this definition would be any interest, dividends, rents and royalties.
Organizational structure must also be considered in determining eligibility. All members of a controlled group for the tax year are treated as a single taxpayer for purposes of applying the gross receipt requirements.
How much is the R&D payroll tax credit worth?
While there is no limit to the research and development tax credit you can claim, there is a limit on the payroll tax offset you can elect.
The maximum annual payroll tax offset a taxpayer can elect is $250,000. Any current-year research credits claimed in excess of the $250,000 maximum remain available to offset income tax liability.
If the company is a part of a controlled group, the control group is treated as a single taxpayer for purposes of the $250,000 limit. An allocation of the $250,000 is made to each control group member based on each member’s qualified research expenses for the current tax year.
How to claim the R&D credit payroll tax offset
The payroll tax offset election must be made on an originally filed return, including extension.
If your company already filed its income tax return for the current year, your opportunity to consider this election is next year. However, if your company has not yet its income tax return, then there is still an opportunity to consider this election.
For a controlled group, each member can separately consider making the election.
When can businesses can start using the payroll tax offset?
If the payroll offset election is made, you can begin to benefit from the payroll tax offset in the first calendar quarter after filing your income tax return.
As an example, if the company filed an income tax return with the payroll credit on March 1, (first calendar quarter), the first calendar quarter after the income tax return is filed is the second quarter (April, May and June of the year). The elected payroll credit offset can be applied to taxes due in relation to the second quarter.
Any payroll credit offset not used in the second quarter can be carried forward to future quarters.
Is the R&D credit payroll tax offset the right election for your business?
Whether or not the payroll tax offset is right for your business depends on your tax strategy.
Is your company eligible? Is the payroll tax offset credit the most beneficial circumstance for your company? Or should the R&D credit remain as a credit carryforward to offset future tax liability? How much should you elect?
These are all valid questions, but the answers depend on your business’s unique situation. Working with an experienced tax advisor can help you build a strategy to maximize all of your credit opportunities.
How Wipfli can help
From complex requirements to maximizing cash flow, navigating tax credits requires a strategy tailored to your business. Connect with our credits and incentives team to talk about how you can capture the full value of your tax opportunities.
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