If your business has increased research activities, you may be eligible to claim a valuable tax credit often referred to as the research and development (R&D) credit. Although claiming the R&D tax credit requires complex calculations, we can help take care of these calculations for you.
In addition to the tax credit itself, you should also be aware of two features that are especially advantageous to small businesses:
- Small businesses with $50 million or less in gross receipts are eligible to claim the R&D credit against alternative minimum tax (AMT) liability
- Certain startup businesses may claim the credit against the employer’s Social Security payroll tax liability
It’s worth taking a closer look at this second feature.
If your business is eligible, your business can elect to apply some or all of the research tax credit you earn against your payroll taxes, rather than your income tax. With this payroll tax election in mind, some small startup businesses may wish to undertake or increase their research activities. And if your business is already engaged in or is planning to undertake research activities, you should be aware that some tax relief may be available to you.
Benefits of the election
Many new businesses pay no income tax and won’t pay tax for some time, even if they have a net positive cash flow and/or a book profit.
Because of this, new businesses typically have no amount to apply business credits, including the research credit, against. However, even a new wage-paying business will have payroll tax liabilities.
The payroll tax election thus offers new businesses a chance to more quickly use the research credits they earn. Since every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, this election can serve as a major boon to businesses during the start-up phase when help is most needed.
What businesses are eligible?
In order to be eligible for the election, a taxpayer must:
- Have gross receipts for the election year that are less than $5 million
- Be no more than five years past the startup period (the period for which it had no receipts)
Only the gross receipts from the taxpayer’s business are taken into account in making these determinations. Other income such as an individual’s salary or investment income aren’t taken into consideration.
You should also note that an entity or individual can’t choose to make the election for more than six straight years.
Limitations
If an individual chooses to make the payroll tax election, the research credit for which the election is made may only be applied against the Social Security portion of FICA taxes. The credit can’t be applied against the “Medicare” portion of FICA taxes or any FICA taxes that are withheld and remitted to the government on behalf of employees.
In addition, the election can’t be made on research credit amounts in excess of $250,000 annually. For C corporations and individual taxpayers, the election can only be taken for research credits that would have to be carried forward in the absence of an election. This means that C corporations can’t make the election for amounts that the taxpayer could use to reduce their own income tax liabilities.
Identifying and substantiating expenses eligible for the research credit is a complex undertaking, and these are only the basics of the payroll tax election. If you have further questions or believe you may benefit from the payroll tax election, contact us.