The research and development tax credit was created in 1981 to encourage the development of new products, processes and computer software in the United States. Prior to the 2015 Protecting Americans from Tax Hikes (“PATH act”), the R&D credit could be used only to offset Federal Income Tax. There was no dollar limit on the size of the credit and it could be carried forward for 20 years. This placed many small “start-up” companies at a disadvantage since they were not receiving immediate benefits due to incurring tax losses.
The 2015 PATH act made several advantageous changes that can help many start-ups:
- R&D credit became permanent
- R&D credit can be used to offset payroll tax for a qualified small businesses
- R&D credit can be used against the AMT tax for certain eligible entities
A qualified small business is a corporation (including an S Corporation) or partnership with gross receipts of less than $5 million for the tax year and had no gross receipts for any tax year before the five-taxable-year period ending with the tax year of the election. For example, for a 2017 payroll tax offset election, the taxpayer cannot have had revenue prior to January 1, 2013.
A qualified small business may elect to claim up to $250,000, subject to certain limitations, of its credit for increasing research activities as a payroll tax credit against the employer’s share of social security tax. The election is made on a timely filed federal tax return (including extensions). The payroll tax offset occurs in the quarter immediately following the quarter in which qualified small business filed its income tax return. So, if you are a calendar year taxpayer and you file your 2017 income tax return on March 15, 2018, then the 2018 second quarter 941 which is filed by July 31, 2018, is the first quarter that you can take the qualified small business payroll tax credit for increasing research activities. Any amount in excess of the quarterly payroll tax liability is carried forward to the next quarter. The payroll tax offset election is limited to a total of 5 tax years (assuming the taxpayer meets the qualifications as a qualified small business for each year) and may not be revoked without IRS consent.
In order to claim the credit, taxpayers will need to file the following:
- Form 6765 (Credit for Increasing Research Activities) – filed with the taxpayer’s federal income tax return
- Form 8974 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities) – attached to the taxpayer’s Form 941
- Form 941 (Employer’s Quarterly Federal Tax Return) – the credit calculated on Form 8974 will be carried over to Line 11 of the Form 941
If the taxpayer ceases to qualify as a qualified small business, they may still claim the research and development credit against income tax instead of payroll tax.
If you have any questions or would like further information, please contact one of our tax advisors.