Wondering How to Offset Payroll Tax with R&D Tax Credits?
Intrepid Advisors often receives questions related to the R&D tax credit and how it can benefit startups and small companies in particular.
The Protecting Americans from Tax Hikes Act of 2015 (The PATH Act) created an opportunity for qualified small businesses to offset all or a portion of their contribution to payroll tax using federal R&D tax credits for up to five years. Business owners and executives interested in saving valuable payroll tax dollars need to understand the following key points.
What is a Qualified Small Business?
For 2016 and subsequent tax years, businesses may use their R&D tax credits to offset payroll tax providing they meet the following requirements:
- It had gross receipts1 for 5 years or less
- It had less than $5 million in gross receipts in the year the R&D credit is claimed
- It had qualifying research activities and expenditures
1Gross receipts means total revenue less returns and allowances, including all amounts received for services, income from investments, bank interest, and all other incidental or outside sources.
Note that, for a company wishing to use its 2017 R&D tax credits to offset its payroll tax in 2018, it could not have had any gross receipts prior to 2013.
What is the Maximum Benefit?
R&D tax credits are applied against quarterly payroll tax payments for up to as many as five years. In any given year, a company can apply up to $250,000 against its contribution to the Social Security tax of 6.2% of each employee’s salary (up to a maximum of $128,400 per employee in 2018).
Example 1: A start-up software company claimed a $65,000 R&D tax credit on its 2017 federal return – all of which could be used to offset its payroll taxes in 2018.
Example 2: An early stage biotech company claimed a $270,000 R&D tax credit in 2017; however, only $250,000 can be applied to payroll taxes in the current year, the remaining $20,000 would be used to offset ordinary income tax or carried forward to the next year.
How Does it Work?
The payroll tax offset is available on a quarterly basis beginning in the first calendar quarter after a taxpayer files its federal income tax return.
Step 1: Complete Form 6765, Credit for Increasing Research Activities, making the election for the payroll tax credit, and attach the completed form to the corporate income tax return.
Step 2: Claim the payroll tax credit by completing Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. This form must be attached to the quarterly payroll tax return, Form 941, Employer’s Quarterly Federal Tax Return.
Any unused credits can be carried forward to the subsequent quarters.
Can the R&D Credit be Applied to the First Payroll Payment of a Quarter?
The answer is YES. On July 31, 2017, the IRS issued Memorandum AM2017-003 in response to questions regarding timing issues concerning the payroll tax offset. While the advice may not be used or cited as precedent, it offers useful guidance on how and when employers may use R&D tax credits to offset their payroll tax.
The Memorandum states, “Starting with the first payroll payment of the quarter that includes payments of wages subject to social security tax to its employees. In determining the amount to enter on the Record of Federal Tax Liability, the employer should reduce tax liability by the lesser of: (A) the amount of the employer social security tax on the wages or (B) the available payroll tax credit. The memorandum includes instructions on how to complete Form 941 using this process.”
This is especially good news because employers can apply their R&D tax credits against payroll deposits rather than filing for a refund at the end of the quarter.
Can the Payroll Tax Offset be Elected on an Amended Return?
The IRS memorandum addressed this question as well, “If a qualified small business that filed a tax return not electing the payroll tax credit files an amended tax return electing the payroll tax credit, the taxpayer claims the payroll tax credit on its employment tax return for the quarter beginning after the date the amended return was filed and may not claim the payroll tax credit elected on that amended return in an earlier quarter.” However, the taxpayer must file the amended return by the end of the calendar year in which they filed their original return. For example, the taxpayer must amend an already filed 2017 tax return by December 31, 2018 in order to claim the payroll tax credit.
What if My Company Uses a PEO?
Professional Employer Organizations (PEOs) that pay wages to individuals as part of the services provided to a client, can claim the payroll tax credit on behalf of the qualified small business. As long as the qualified small business elected to apply its R&D credit against the payroll tax on its federal return for the previous tax year.
How Do I Determine if My Company Qualifies for an R&D Tax Credit?
Intrepid Advisors assists hundreds of small businesses and start-up companies identify their qualifying development activities and expenses, compute their R&D tax credits, and prepare the necessary supporting documentation as well as assist them with the payroll tax offset. If you think your company might be eligible to take advantage of the payroll tax offset or to learn more about the R&D tax credit, contact us for a no-cost consultation and free assessment.