If you have a start-up company or new business, you may be able to apply the R&D tax credit against payroll taxes for five years. The R&D credit was extended permanently with the PATH Act of 2015 (Protecting Americans from Tax Hikes). The bill purposefully included enhancements to help offset payroll tax and the alternative minimum tax for businesses that are eligible.
What determines a company’s eligibility?
Even companies that do not show a profit may receive benefits from the Payroll-tax offset. These are the qualifications that determine eligibility:
- Businesses with gross receipts (including interest income) for five or fewer years
- Companies accumulating less than $5 million in gross receipts in the year the being credited
- Entities conducting qualifying research expenditures and activities
- Those determining they have payroll-tax liability
Possible Benefits of the Payroll-Tax Offset
A brand new business may be able to claim this credit for up to five years. The total credits claimed on quarterly federal payroll returns cap at $1.25 million. But most start-up companies and new businesses could see a benefit somewhere between six and 14% of eligible R&D costs. For companies incurring eligible R&D costs of at least $300,000, the payroll-tax offset credit equals 10% of their total R&D expenses. What happens if the credit amounts exceed the company’s Social Security tax liability in any quarter? The excess carries forward into the next calendar quarter.
Does claiming the R&D Credit pose any risks?
Most employers deposit federal payroll taxes either monthly or semiweekly. They also have to file a payroll tax return at the end of every quarter. In some instances, the credit is applied against payroll taxes either monthly or semiweekly. This eliminates having to wait until the end of the quarter for the refund.
More IRS Scrutiny
When a company begins to use the credit, it opens them up to a higher level of scrutiny from the IRS. This is because the IRS prioritizes R&D credits. The IRS creates industry-specific teams comprised of specialists that help to review R&D credit claims. Even small businesses are under the scrutiny of IRS examinations. Generally, larger credits will get more attention from the IRS, and they will require more documentation and review.
Complex Accounting Rules and Guidelines
Some companies opt out of R&D credits simply because of the complexity of the rules. They also change frequently and can be difficult to keep up with. New regulations, court cases, IRS guidelines, and legislation constantly shift the landscape of the payroll-tax credit. Without the proper level of documentation and review, companies often receive penalties. Working with an attorney or a CPA who is familiar with the tax law can help prevent penalties and help with the IRS examination and appeals process if necessary.
R&D Credit Required Documentation
The most important thing is to have all your documentation in place. Unfortunately, there isn’t a cookie-cutter formula that fits all companies. The size and scope of claimed credit amounts demand various levels of documentation. The first year of setting up your processes to claim the R&D credit will take a lot more commitment. This is also the time to put all the appropriate measures in place for moving forward. Depending on the company’s size, profits, payroll, and other factors historic R&D spending may need to be re-evaluated as well.