As a startup or small business owner, you constantly seek ways to fuel your innovation while managing costs. Enter the R&D Payroll Tax Credit – a powerful tool to help offset your payroll expenses and inject much-needed cash into your business. If your company invests in research and development activities, this credit could be a game-changer for your financial strategy.
Indinero’s in-house tax team has years of experience in this subject and is here to save you money. We offer an R&D study service for those who want to take advantage of this credit. Through a brief call with Indinero’s R&D tax experts, we can conclusively determine if your business qualifies for substantial tax savings.
Follow along for an R&D Payroll Tax Credit breakdown, and download our comprehensive R&D Tax Credit Guide for more detailed information on the program.
What is the R&D Payroll Tax Credit?
The R&D Payroll Tax Credit is a provision of the Research and Development (R&D) Tax Credit that allows eligible startups to offset a portion of their payroll taxes. This credit was introduced as part of the Protecting Americans from Tax Hikes (PATH) Act of 2015, making the R&D Tax Credit more accessible to small businesses and startups.
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 and claiming three types of expenses: wages, contract research, and supplies. The credit calculation was designed so the government subsidizes additional research your company would not otherwise have undertaken.
How the R&D Payroll Tax Credit Works
Under this provision, qualified small businesses can apply up to $250,000 of their R&D Tax Credit against the employer portion of Social Security taxes (FICA) each year. This is particularly beneficial for startups and small businesses that may not have significant income tax liability but still have substantial payroll expenses.
Eligibility for the R&D Payroll Tax Credit
To qualify for the R&D Payroll Tax Credit, your business must meet the following criteria:
- Gross receipts for the credit year must be less than $5 million
- No gross receipts for any tax year preceding the 5-tax-year period ending with the credit year
- Qualifying research activities and expenditures as defined by the IRS
Maximizing the Benefits of the R&D Payroll Tax Credit
The R&D Payroll Tax Credit can provide significant benefits to eligible businesses:
- Immediate Cash Flow: By offsetting payroll taxes, the credit provides immediate cash flow benefits, even for companies not yet profitable.
- Substantial Savings: Eligible businesses can claim up to $250,000 per year for up to five years, potentially saving up to $1.25 million in payroll taxes.
- Reinvestment Opportunities: The money saved through the R&D Payroll Tax Credit can be reinvested into further research and development activities, fueling innovation and growth.
Claiming the R&D Payroll Tax Credit
To claim the R&D Payroll Tax Credit, follow these steps:
- Determine eligibility and calculate your R&D Tax Credit
- File Form 6765 with your income tax return, electing to apply the credit to payroll taxes
- File Form 8974 with your quarterly Form 941 to claim the credit against your payroll taxes
Common Misconceptions About the R&D Payroll Tax Credit
Misconception #1: It’s only for tech companies.
The R&D Payroll Tax Credit is available to businesses in various industries, not just technology or pharmaceuticals.
The IRS relies on a test to determine whether your research meets four elements: specificity, discovery, experimental, and technological. See our R&D Tax Credit Questionnaire article for more information on the R&D Credit Four-Part Test.
Misconception #2: We need to be profitable to benefit
Even if your company isn’t profitable, you can still benefit from this credit by offsetting payroll taxes.
Misconception #3: The credit is too complex to claim
While the process can be complex, working with experienced tax professionals can make claiming the credit manageable and worthwhile.
Qualified Small Business (QSB) Criteria
To be eligible for the R&D Payroll Tax Credit, your company must meet the definition of a Qualified Small Business:
- Revenue Cap: Your business must have less than $5 million in gross receipts for the credit year.
- Limited Operating History: You cannot have gross receipts for any tax year preceding the 5-tax-year period ending with the credit year. For example, if you’re claiming the credit for 2023, you cannot have had gross receipts before 2019.
- Non-Exempt Status: Your organization must not be tax-exempt under section 501 of the Internal Revenue Code.
Qualified research activities
- 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
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). 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.
Credit Amount and Duration
Qualified Small Businesses can:
- Apply up to $250,000 of their R&D tax credit against payroll taxes each year
- Utilize this benefit for up to five years
- Potentially offset up to $1.25 million in payroll taxes over the five years
This provision is particularly valuable for startups and young companies that may not yet have significant income tax liability but have substantial payroll expenses.
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 correctly, the R&D credit is a worthwhile investment of time and money. We are talking about tax law. So, know how to qualify, be ready to show the IRS 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 advantage of the credit, indinero can ensure you’re getting the maximum amount of credit and help you maximize your cash savings.
Eight reasons why the R&D Tax Credit and Payroll Offset is a rare tax treat for your business
- You get a dollar-for-dollar credit (it’s not a deduction).
- You can apply for the R&D credit against your payroll tax for up to five years.
- You can retroactively apply for the tax credit back three open tax years. Loss companies may be able to go back even further!
- The federal government and the state where you pay taxes can credit you for qualified expenses related to R&D activities.
- You are not limited to an amount of credit that can be claimed each year.
- You can carry forward unused R&D credit for up to 20 years. You can carry back the R&D credit for one year. Note: States have their own carryover rules.
- You can turn up to 10% of R&D expenses into available cash or $1.25 million over five years.
- You can use the R&D credit to offset your regular and alternative minimum tax rates.
Indinero’s accounting and tax expertise includes the R&D Study. Let us maximize your innovation. Schedule a consultation with our R&D credit experts.
