Without question, one of the major highlights of the recently enacted PATH Act of 2015 is the provision making the R&D Tax Credit permanent. The permanency of the credit provides the owners and leaders of manufacturing and technology companies the fiscal certainty necessary to make important decisions concerning their investments in innovation without heed of Congress’ political whims. The research tax credit, which had been a temporary tax measure until 2016, needed to be extended every year or so since inception in 1981.
In addition to extending the R&D credit indefinitely, the landmark bill provides tax relief for start-up companies engaged in innovation, allowing qualified small businesses to offset a portion of their payroll taxes using R&D credits. As with most things created by the Government, the rules relating to the payroll tax offset can certainly seem confusing and a mouthful to explain. “Why make it simple when complicated will do,” a colleague offered.
For those interested in saving valuable payroll tax dollars, the key things to remember are these:
- For tax years beginning in 2016 and thereafter, qualified small businesses may offset the 6.2% FICA portion of their payroll taxes using R&D tax credits claimed on returns filed for tax years beginning after 2015. In other words, the soonest payroll tax savings can be had is in 2017, after filing ones 2016 federal return.
- Qualified small businesses are defined as corporations or partnerships having gross receipts of $5,000,000 or less during the taxable year, and that did not have gross receipts for any year preceding the 5-year period ending with the taxable year.
- R&D tax credits are applied against quarterly payroll tax payments. In any given year, the maximum payroll tax offset allowed is limited to $250,000. Unused credits may be carried forward and used against future payroll tax payments.
To demonstrate how the new regulations would apply to a typical start-up company, have a glimpse of the following example.
A manufacturing company founded in 2014 was established by two college friends for the purpose of developing and producing a line of state-of-the-art components for the consumer sound-system market. The owners of the business invested their personal savings into the enterprise and by late 2015 had sold their first 1000 products for a sum of $500,000. Entering 2016, the company had seven employees on staff, including the owners, all of which received a W2 salary. Throughout 2016, the company continued its product development and manufacturing efforts, which resulted in revenue of $1,000,000 while incurring $800,000 of qualifying research expenses. In early 2017, the company filed its 2016 tax year return, showing a net loss of $1,200,000 and an R&D credit of $48,000. The company subsequently offset $15,500 owed for the FICA portion of its first quarterly payroll tax payment in 2017 using R&D credits, carrying forward a $32,500 credit balance for the next quarterly payroll tax filing.