R&D Tax Credits Can Offset Payroll Liability for Your Small Business or Start-Up

R&D Tax Credits Can Offset Payroll Liability for Your Small Business or Start-Up

Posted by Jeffrey Feingold on 01.04.19

In the past, start-ups that were not paying federal income taxes could claim R&D tax credits, but would then need to carry them forward on their corporate and/or shareholder tax returns until they could offset their income tax liabilities. Today, small businesses and start-ups across the U.S. can use part if not all of those same R&D tax credits against their payroll tax liability as well. The new provisions of the R&D credit for the small business payroll tax credit are complex. Companies should act quickly to determine their eligibility by consulting a CPA or Tax Point Advisors to ensure that the small business payroll tax credit applies to their company’s liabilities.

The R&D Tax Credit

The R&D tax credit, originally enacted as part of the Economic Recovery Tax Act of 1981 was designed to encourage investment in innovation in the United States. The credits are also intended for activities related to process design and development. Examples include new techniques, formulas, processes, software and the use of new materials to create more reliable, energy-efficient products or processes. Costs that qualify for the credit include wages of employees involved in developing new or improved products or processes, fees paid to outside contractors in the U.S. who provide qualifying R&D services on behalf of the taxpayer, and the cost of supplies used during the research process. It is critical that taxpayers seeking to claim R&D tax credits develop an approach for identifying, quantifying and documenting R&D project costs that may be eligible.

Benefits of the R&D Tax Credit

Federal research and development (R&D) tax credits can deliver an immediate and significant benefit to a company as a result of innovative activities. While the tax credit originally pertained to basic research expenses, such as those occurring in a lab setting, modifications have simplified the credit and made it available to a wider variety of businesses. Hundreds of activities now qualify for this powerful tax savings tool.

R&D tax credits can immediately benefit a company in several ways:

  • Source of cash for reinvestment or other needs
  • Significant reduction to current and future tax liabilities
  • Credits may carry forward up to 20 years

To learn more about the benefits of R&D credits, read our success stories.

R&D Tax Credits Can Offset Payroll Liability 

Tax law changes have made it more attractive and possible for smaller businesses to take advantage of the R&D tax credit. In December 2015, the Protecting Americans from Tax Hikes (PATH) Act of 2015 was signed into law. In addition to making the R&D tax credit permanent, this legislation benefitted a large number of taxpayers who had been previously unable to take advantage of the powerful incentive due to their particular tax situation. The legislation allows small businesses to claim the R&D tax credit against their alternative minimum tax (AMT). The AMT restriction has long prevented qualified companies from utilizing the research credit. This new legislation removed that obstacle for qualified businesses with less than $50 million in gross receipts. The PATH Act also allows startup businesses with gross receipts of less than $5 million to claim the R&D tax credit against their payroll taxes, substantially making it a refundable credit for up to five years. The new payroll tax offset allows companies to receive a benefit for their R&D activities regardless of profitability.The maximum benefit an eligible company can claim against payroll taxes each year under the new law is $250 thousand dollars.  

The new payroll tax offset is available to companies that meet these qualifications:

  • Gross receipts for five years or less
  • An average of $5 million in gross receipts or less within the last five years
  • Qualifying research activities and expenditures
  • Payroll Tax Liability

On March 30, 2017, the IRS offered some direction in the form of Notice 2017-23 that describes how eligible small businesses can apply all or part of their R&D tax credits against their payroll tax liability. Notice 2017-23 focuses on the definition of gross receipts, a collection of rules, and the time and manner of making the choice to claim the payroll tax credit. The IRS confirmed that gross receipts include the following; total sales (defined as the net of returns and allowances), all amounts received for services, and income from investments (including interest income). 

Activities Must Meet A Four Part Test

While R&D tax credits are available, it can be challenging to navigate through the complexities involved with qualifying for the tax credit and the necessary documentation. For example, to be eligible, an activity must meet a four-part test. A knowledgeable R&D tax credit expert can help determine which activities qualify and help you with the required documentation.

The 4 Part test

            1. Qualified Purpose - The purpose of the research must be to create a new or improved product, process, or formulation, resulting in increased performance, function, reliability or quality. 

            2. Technological in Nature – The research must rely on the hard sciences, such as engineering, physics, chemistry, biology or computer science. 

            3. Elimination of Uncertainty – Activities must overcome some unknowns, such as uncertainty as to capability, optimal design, or optimal methodology. 

            4. Process of Experimentation – Experimentation can be demonstrated through test batches, simulations, systematic trial and error, or other methods of evaluating alternatives to achieve a desired result. 

Watch this video: How to Qualify for R&D Tax Credits: The Four-Part Test

R&D tax credits can provide a significant financial advantage to businesses of all sizes, allowing both reduced tax liability and cash back for reinvestment or other needs.  Most small businesses need to be aware they too can unquestionably benefit from R&D tax credits. Start-ups and small to medium size companies can be using all or part of their R&D credits against their payroll tax liability. The payroll tax offset is available to new businesses and startup companies for up to 5 years. What’s important to note, any unused R&D credits that are not elected to offset payroll taxes may be carried forward for up to 20 years and used when the business becomes profitable. For that reason alone, it’s very important for any small business or start-up to find an advisor that specializes in R&D tax credits. 

To learn more about offsetting the payroll tax liability with R&D tax credits from Tax Point Advisors, simply fill out the form on this page and a member of our team will be in touch with you. Or, you may call us at 1-800-260-4138 nationwide.


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