Tax TipsThe R&D Tax Credit and Payroll-Tax Offset Swirl: It’s A Tax Treat for Qualified Small Businesses

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Did you know your business could qualify for a ‘sweet’ tax credit. Does your startup or small business spend money on trial-and-error activities to create a new product or improve a process? If that sounds like your business, the R&D tax credit and the payroll tax offset should absolutely be part of your tax strategy.

The R&D tax credit wasn’t always available to small businesses. Until 2015, the credit had been subject to renewal by Congress, making it less reliable as a tax strategy. All of that has changed. Unfortunately, what remains is a credit to promote innovation by U.S. companies that are complex and confusing.

Have no fear, inDinero is here!

inDinero’s in-house tax team has years of experience in just this subject and is here to save you money with this credit. We offer a R&D study service for those who want to take advantage of this credit. Over a brief call with inDinero’s R&D tax experts, we can determine if your business qualifies for this significant tax savings.

Follow along for a brief R&D credit breakdown and how it and the payroll offset work together like a perfect chocolate and vanilla swirl🍦.

 

What is the R&D Tax Credit?

The Research and Experimentation Tax Credit (aka research and development or R&D tax credit) was established in 1981 by IRS code §41 to incentivize U.S. firms to conduct more research and develop new products to bolster our country’s GDP and global competitiveness.

The R&D tax credit is a dollar-for-dollar credit against taxes owed in a given year so long as it can show that it is conducting qualified research activities. There are three types of expenses to claim: wages, contract research, supplies. The credit calculation was designed so that the government subsidizes additional research that your company would not otherwise have undertaken. For more details on calculating the R&D tax credit, download a free copy of the TITLE Guide.

Many states offer an R&D credit, adding to your company’s potential tax savings and extra cash. Did ‘tax savings’ put a smile on your face? You may be able to offset FICA payroll taxes if you qualify, so read on!

 

Four common misconceptions about the R&D Tax Credit

Misconception #1: The R&D credit only applies to tech or pharma companies, not my company.

Our first myth to bust is that the R&D Credit is only for companies with traditional white-lab-coat activities led by a Ph.D. — false! In fact, companies that hire outside contractors to conduct research, develop a new process for internal use, or improve upon existing products may also be eligible for Federal and State R&D credit.

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The IRS relies on a test to determine whether your research meets four elements: specificity, discovery, experimental, and technological. See TITLE Guide for more information on the R&D Credit Four-Part Test.

 

Misconception #2: You can’t count on the credit. Why go through the trouble?

In 2015, the Protecting Americans from Tax Hikes Act (PATH Act) changed the tax code to permanently include the R&D tax credit. Meaning, unlike pre-2015, when the R&D credit had to be renewed by Congress, now it’s here to stay. Even the recent Tax Cuts and Jobs Act (TCJA) legislation retained the provisions on R&D. All this to say, your company should include R&D credit in its tax strategy, if possible.

 

Misconception #3: I don’t owe federal income taxes so it wouldn’t do much for me anyway.

You may not have taxable income but that doesn’t mean you can’t take advantage of the R&D tax credit.

The PATH Act allowed Qualified Small Businesses (QSB) to apply up to $250,000 each year for five years (for a total of $1.25 million) to offset the employer portion of Social Security taxes due. A QSB:

  • Is a business with gross receipts of less than $5 million in a given year and
  • Doesn’t owe gross receipts or interest income dating back more than five years from the credit year. Translation: You elect an R&D tax credit in 2021, then you cannot have had gross receipts before 2017.
  • Is not a tax-exempt organization.

 

Misconception #4: We haven’t claimed it before, and we’re conducting R&D for our internal processes. We’re not going to license or sell anything new with these findings.

You might think that you have to create a new “widget” and sell it for your research and development work to qualify as R&D credit-worthy. That’s not entirely correct.

Qualified research activities include:

  • Pre-production design & engineering of a new product or improved existing product
  • Experimenting or testing new concepts, formulations, materials, tools, and procedures
  • New process or production improvements
  • Prototyping and patent applications
  • Software development for internal* use or sale
  • General trial and error experimentation

As you can see, there’s no requirement that you have to be creating or selling a new product.

*It is possible that expenses related to developing a new internal process or production improvement will qualify for the R&D credit. Talk with an inDinero R&D credit expert who can determine whether your project will pass the R&D credit test.

 

What is the Payroll Tax Offset?

We covered QSB earlier, but it’s worth revisiting. A QSB can receive a credit of up to $250,000 a year and apply the non-refundable credit toward the employer portion of payroll taxes (social security). Basically, suppose your company operates at a loss. In that case, you can use the offset against current payroll taxes (the 6.2% of FICA that your business pays) until it’s fully used. The payroll credit benefits small and large companies. If you owe payroll tax, you can benefit from the offset of the Social Security tax in that credit year for cash on hand.

 

How do you claim the R&D credit?

To claim the R&D tax credit, your tax preparers need to file Form 6765 along with your income tax filings. To claim the payroll tax offset, you need to file on time (including extensions) and must elect the payroll tax offset on your Form 6765.

 

Why would small businesses and startups want to elect the R&D Credit?

Hopefully, it is easy to see what is so attractive about the R&D credit and Payroll offset ‘swirl’. If done properly, the R&D credit is a worthwhile investment of your time and money. We are talking about tax law. So, know how to qualify, be ready to show the IRS that you’re eligible, and learn how to use the sweet R&D tax credit, and payroll offset correctly.

If you aren’t already taking advantage of this credit, perhaps you’re leaving money on the table. If you are taking the credit, inDinero can make sure you’re getting the maximum amount of credit and help you maximize your cash savings.

Remember these eight reasons why the R&D Tax Credit and Payroll Offset is a rare tax treat for your business:

  1. You get a dollar-for-dollar credit (it’s not a deduction).
  2. You can apply for the R&D credit against your payroll tax for up to five years.
  3. You can retroactively apply for the tax credit back three open tax years. Loss companies may be able to go back even further!
  4. You can get a credit for qualified expenses related to R&D activities from the Federal government and the State where you pay taxes.
  5. You are not limited to an amount of credit that can be claimed each year.
  6. You can carry forward unused R&D credit up to 20 years. You can carry back the R&D credit for one year. Note: States have their own carryover rules.
  7. You can turn up to 10% of R&D expenses into available cash or $1.25 million over five years.
  8. You can use the R&D credit to offset your regular taxes and alternative minimum tax rate. Download inDinero’s free R&D tax guide to find out more about how.

inDinero’s accounting and tax expertise includes the R&D Study. Let us maximize your innovation for you. Schedule a consultation with our R&D credit expert.

inDinero R&D tax credit guide
Quick Note: This article is provided for informational purposes only, and is not legal, financial, accounting, or tax advice. You should consult appropriate professionals for advice on your specific situation. inDinero assumes no liability for actions taken in reliance upon the information contained herein.

Marc Caccavelli

Marc is a Tax Director with Indinero. He has been employed out of the NYC office for the past year, and he has a significant amount of tax background related to tax compliance, tax provisions, tax research and tax planning. He has also worked in the past for 2 Big 4 Accounting Firms and also larger corporations with a nationwide and international tax presence.

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