In December 2015, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) made three important changes to the research and development (R&D) tax credit, at least one of which could significantly impact startup and pre-revenue companies.
Qualifying small businesses can now use a portion of the R&D credits they generate against the 6.2% payroll tax imposed on business wage payments to employees. This was not an option prior to the PATH Act, meaning companies not yet generating income could carry forward their R&D credits but couldn’t use them in the current year.
A qualified small business is defined as a partnership or corporation with:
- Gross receipts less than $5 million, and
- No gross receipts from more than five years ago.
The same rules apply for sole proprietors, except gross receipts include receipts from all trades or businesses.
How Does a Small Business Elect the Credit?
Once it has been determined that your business is a qualified small business and generating an R&D credit, the process of claiming the credit is relatively simple. Here are the forms you will need:
- Form 6765 – Credit for Increasing Research Activities. If you’re generating an R&D credit, you should already be filing this form.
- Form 8974 – Qualified Small Business Payroll Tax Credit for Increasing Research Activities. Form 8974 calculates the payroll tax credit amount that is allowed for the current year, using information from Form 6765.
- Form 941 – Employer’s Quarterly Federal Tax Return. The final credit amount from Form 8974 is used on your quarterly filing. Form 941 is the form you or your payroll provider is already filing to determine your employer portion of Social Security and Medicare taxes. When filing Form 941 with a payroll tax credit, you also must attach a copy of Form 8974.
When Is the Credit Applied?
The portion of the credit that is being used to offset the employer’s portion of taxes is applied to the first calendar quarter after the income tax return containing the election is filed. For example, a qualified small business that made the payroll tax credit election on their 2016 tax return that was filed on March 15th would apply the portion of the payroll tax credit to their 2017 second quarter payroll tax return.
What Are the Limitations?
The amount of the R&D credit a qualifying business can elect to allocate against payroll taxes is the smaller of:
- the R&D credit in its entirety or
- the business’s general business credit carryforward.
Keep in mind, the payroll tax credit can only be used against the employer portion.
The R&D credit with a payroll tax credit election can be a powerful tool for a qualified small business. It allows the business to receive benefits from the R&D credit sooner, rather than waiting until there is revenue to offset. If you conduct R&D activities and think your business is a qualified small business, speak with your tax advisory team to discuss the option of electing the payroll tax credit.
For more information contact Josh Messina, head of our Tax Credits & Incentives Group, at firstname.lastname@example.org or Alex Schneider at email@example.com.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.