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How the R&D Credit Can Help New Companies Offset Payroll Taxes

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How the R&D Credit Can Help New Companies Offset Payroll Taxes

The R&D credit was permanently extended as part of the Protecting Americans from Tax Hikes (PATH) Act of 2015. The bill included enhancements starting in 2016, including offsets to the alternative minimum tax and payroll tax for eligible businesses.

While the credit used to offset payroll, taxes is based on eligible R&D expenses, it only applies to costs incurred after the bill was signed into law. The maximum benefit an eligible company can claim against payroll taxes each year under the PATH Act is $250,000.

 

So How Does It Work?

Identify

Identify and document the R & D tax credit that is available on your annual tax return.

Elect

Elect the credit amount that may be used to offset payroll taxes

Claim

Claim the credit on your quarterly tax return following the filing of your annual tax return with the election

Carry Forward

Carry the credit forward to the following calendar quarter if it is not used up.

 

Questions and Answers

The most common questions and answers related to the R&D credit and how to apply it against payroll taxes are provided below.

When does the payroll-tax offset take effect?

The payroll-tax offset is currently available for qualified expenses incurred in 2019. The R&D credit must be calculated and shown on a taxpayer’s 2019 federal income tax return with the portion of the credit applied to offset payroll taxes identified and elected when the return is filed in 2020. The offset is then available on a quarterly basis beginning in the first calendar quarter after a taxpayer files their federal income tax return.

For example, taxpayers need to file their 2019 federal income tax return by March 31, 2020, to apply the payroll-tax offset to the second quarter. As a result, the earliest taxpayers are likely to see a benefit is July 2020 when they file their quarterly payroll tax return for the second quarter.

How quickly does a company need to move on this? When does it need to get started?

The current opportunity to offset payroll taxes is based on 2019 expenses, which means companies can benefit from acting quickly to determine their eligibility under the new rules and start planning. This will help ensure companies understand what types of information will need to be gathered at the end of the year.

This credit must be specified, elected, and filed in the original 2019 tax return before it can be used to offset payroll taxes. Under the current rules, taxpayers cannot take advantage of this opportunity on an amended return.

What companies qualify for the offset?

The new payroll-tax offset allows companies to receive a benefit for research activities even if they aren’t profitable. To be eligible for the credit, companies must meet these qualifications:

  • Gross receipts for five years or less (interest income counts toward gross receipts)
  • Less than $5 million in gross receipts in the year the credit is elected
  • Qualifying research activities and expenditures
  • Payroll-tax liability

Which companies qualify as having gross receipts for five years or less?

Companies aren’t eligible if they generated gross receipts prior to 2015. However, companies that existed prior to 2015 but didn’t receive gross receipts could still qualify.

Although the law is intended to benefit small businesses, larger businesses could potentially still profit. For example, a significant percentage of life-sciences companies have no gross receipts for long periods of time because they’re waiting for their drug to receive approval from the US Food and Drug Administration.

How is $5 million in gross receipts defined?

A company must have less than $5 million in annual gross receipts to be eligible. For new businesses, the gross receipts must fall under the $5 million limit after being annualized for a full 12 months. The gross receipts of businesses that are related or share common ownership need to be calculated on a combined basis for purposes of determining eligibility under this provision.

The IRS issued interim guidance on the definition of gross receipts in March 2017. In the guidance, the IRS confirmed gross receipts include the following:

  • Total sales—defined as the net of returns and allowances
  • All amounts received for services
  • Income from investments, including interest income

Although the gross-receipts limitation helps to define a company’s eligibility for the credit, it’s important to note the R&D credit itself isn’t based on gross receipts. The actual credit is based on the company’s eligible R&D expenses.

 

Learn more about the Benefits and qualifications for the Research & Development Tax Credit

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