This is a guest blog post by Jon Rausch, Partner with the Austin office of accounting firm Montgomery Coscia Greilich LLP. I invited him to write about the R&D tax credit, because it is an issue many CEOs may not know about and could benefit from in 2016 and beyond. While the R&D credit has been around since 1981, the opportunities for small businesses to take advantage of the credit (i.e., payroll tax credit) even when the entity is not paying income tax is brand new for 2016.
With the release of the Protecting Americans from Tax Hikes (PATH) Act of 2015, the popular Research and Development tax credit was made permanent for future years. This encourages businesses to invest more in research and development by offering a tax credit for spending on qualified research expenses.
With the PATH Act came two new changes to the Research and Development tax credit, both favorable to small businesses. First, it provides that beginning in 2016 eligible small businesses ($50 million or less in gross receipts) may claim the credit against alternative minimum tax (AMT) liability.
Secondly, under Code Sec. 41(h), a qualified small business (QSB) can elect for any tax year to claim a certain amount of its research credit as a payroll tax credit against its employer payroll tax liability (up to $250,000 per year), rather than its income tax liability. Meaning, a “start-up technology/engineering-based” company does not have to pay income tax in order to monetize the research tax credit. In addition, a number of states have research credit opportunities.
Once calculated, the amount of credit is allowed for the first calendar quarter, which begins after the date on which the business files its annual tax return. The payroll tax credit cannot exceed the payroll tax imposed for any calendar quarter on wages paid for the employment of all individuals under the employer. Any excess of the credit is carried to the next calendar quarter and allowed as a credit for that quarter.
To meet the requirements of a qualified small business (QSB), an entity:
- Must have gross receipts under $5 million, and
- Must not have gross receipts for any tax year before the five-tax-year period ending with the tax year. (For example, an entity is not eligible for 2016 if it generated gross receipts prior to 2012.)
The payroll tax credit offset is generally limited to start-up businesses that are in the early stages of existence and have not earned gross receipts for more than five years. However, this new law does not require a business to have been in existence for five years.
The payroll tax credit offset also allows a start-up business to make the election for a year before the first year in which the business has gross receipts, depending on the entity’s circumstances. Because the decision to claim the payroll tax credit offset can be made on an annual basis, it is important to discuss the options with a qualified tax advisor to appropriately plan for future years.
Generally, the research credit is most applicable to the following industries: technology, software, life sciences, engineering, and consumer products/manufacturing.
Please note this is a new tax law as of 1/1/2016 and further regulatory guidance will be forthcoming in the next few months.