By Alex Pak on April 20, 2022
The Research and Development (R&D) tax credit can benefit startups and small companies through something known as the Payroll Tax Credit. The R&D payroll tax credit became available to qualified small businesses through the Protecting Americans from Tax Hikes Act of 2015 (The PATH Act). This tax law 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. Prior to this time period, businesses could only take the research credit against their income tax liability.
When it comes to determining how to offset payroll tax with R&D tax credits, business owners and executives interested in saving valuable payroll tax dollars need to understand the following key points.
For 2016 and subsequent tax years, businesses can use their R&D tax credits to offset payroll tax providing they meet the following requirements:
The Payroll Tax Credit cannot be claimed on amended returns. For amended claims, taxpayers can only generate credits to offset income tax liability. However, unused Payroll Tax Credits can be carried forward and applied against payroll tax in subsequent quarters until exhausted, or for 20 years, whichever comes first.
The Payroll Tax Credit cannot be claimed on amended returns. For amended claims, taxpayers can only generate credits to offset income tax liability. However, unused Payroll Tax Credits can be carried forward and applied against payroll tax in subsequent quarters until exhausted, or for 20 years, whichever comes first.
Businesses in multiple industries looking to reduce their Federal and State income tax liability can benefit from the R&D payroll tax credit.
Architecture/Engineering
Aerospace
Blockchain
Construction & MEP
Contract Manufacturing
Consumer Products
Chemical Companies
Financial Industry
Gaming
Metal Fabrication Companies
Mortgage Banking
Pharma / Nutraceutical/ Bioceutical
Plastics Industry
SaaS Platform
Software Development
Tool and Die
Research and development 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 2021).
Example 1: A start-up gaming company claimed a $65,000 R&D tax credit on its 2020 federal return – all of which could be used to offset its payroll taxes in 2021.
Example 2: An early-stage software company claimed a $270,000 R&D tax credit in 2020. They applied $250,000 to payroll taxes and chose to carry forward the remaining $20,000 to the next year.
For a business to claim the R&D payroll taxes credit, you’ll need to have documentation that shows proof of a permitted purpose, technological uncertainty, the process of experimentation, and being technological in nature.
Claiming the R&D payroll tax credit as a qualified small business requires you to elect to apply the research credit against payroll tax liability by completing and submitting Form 6765 to a timely-filed business income tax return. The IRS provides the below steps for claiming the R&D tax credit on payroll taxes:
STEP 1
Complete Form 6765, Credit for Increasing Research Activities and make the election for payroll tax credit and attach the completed form to your timely-filed business income tax return.
STEP 2
Claim the payroll tax credit by completing Form 8974. You must attach this form to your payroll tax return, for example, your Form 941, Employer’s Quarterly Federal Tax Return.
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. Taxpayers can carry unused credits forward to subsequent quarters.
Yes. the IRS issued Memorandum AM2017-003 on July 31, 2017. This was in response to questions regarding timing issues concerning the payroll tax offset. The advice cannot be used or cited as precedent, but it does offer useful guidance on how and when employers can use R&D Tax Credits to offset their payroll tax.
The memorandum includes instructions on how to complete Form 941 using this process. Employers can apply their R&D Tax Credits against payroll deposits rather than filing for a refund at the end of the quarter.
PEOs are Professional Employer Organizations that pay wages to individuals as part of services provided to a client. If your company uses a PEO payroll provider service, the PEO is able to claim the payroll tax credit on behalf of a qualified small business.
The qualified small business will need to have elected to apply its R&D credit against the payroll tax on its federal government return for the previous tax year.
GOAT.tax is powered by Source Advisors, a leading tax consulting firm providing R&D tax credits for almost 4 decades. Source Advisors can assist your small business with:
Founded on the basic principle that the R&D tax credit should be available to companies of all sizes without fees burdening the benefit, the GOAT.tax automated software platform is backed by 350+ years of collective R&D tax credit experience. This is what sets us apart from any other platform. Our people and our experience.
Now is a good time to reexamine prior, current, and future R&D activities in order to take advantage of the R&D tax credit, regardless of industry. If you think your company might be performing work that qualifies, don’t let the potential tax savings go unclaimed. Source Advisors can help you uncover vital tax savings to reinvest in your business and fuel your next big project.
To claim the R&D tax credit, taxpayers have two options. Businesses can claim the R&D tax credit on their tax return for a given year or by amending their prior returns to claim the credit.
The R&D tax credit covers a range of qualifying expenditures, such as employee compensation costs, materials expenses, leased or rented computer equipment, outsourced services expenses.
The R&D tax credit, also known as the Research & Development tax credit, is a federal tax credit designed for qualified businesses to offset their payroll tax - this includes startups. If you have a startup company that performs research and/or technology development activities, you can apply for up to $500,000 of research credit against income tax liability on your income tax return.
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