R&D Tax Credit for Small Businesses & Startups

Does my startup qualify for the R&D Tax Credit?

Starting in the 2016 taxable year, startups can now take advantage of the R&D tax credit to offset payroll tax liabilities. Eligible startups may elect to use the R&D tax credit to offset up to $250,000 of payroll tax liabilities. The credit is limited to five taxable years.

To be considered a “startup” for R&D tax credit purposes, your company must be a “qualified small business.” A qualified small business is:

  • Is a corporation, partnership, or an individual with less than $5 million in gross receipts during the current taxable year in which the R&D tax credit is determined, and
  • The startup cannot have any gross receipts in the taxable years preceding the five-year period that ends with the current credit year.

As a startup, what can the R&D Tax Credit Offset?

The R&D Tax Credit can offset payroll taxes! The election to offset the R&D tax credit against payroll taxes must be made annually at the entity level on a timely filed original income tax or information return for the taxable year for which the R&D tax credit is determined. The portion of payroll tax that can be offset is the employer’s portion of Social Security or old age survivor and disability insurance (“OASDI”), which is generally 6.2% of wages, up to a limit that changes annually.

The offset does not apply to the Medicare portion of payroll tax or the employee or trust fund portion of payroll tax. The payroll tax credit is ultimately reported on the Form 941, “Employer’s Quarterly Federal Tax Return” filed with the first payroll quarter beginning after the tax return is filed to establish the credit. Any excess credits are rolled forward to the next payroll quarter.

How does the R&D Tax Credit help Small Business Owners?

Effective for taxable years starting in 2016, “eligible small businesses” can use the Research & Development (R&D) Tax Credit to offset their Alternative Minimum Tax (“AMT”) liabilities. An “eligible small business” is generally defined in Section 38(c)(5)(C) of the Internal Revenue Code (“IRC”) as a business with average annual gross receipts of $50 million or less for the three preceding taxable years. In the case of a partnership or S corporation, the gross receipts test is applied at the individual owner level. While the Tax Cuts and Jobs Act has eliminated AMT for corporations, AMT is still a possible tax obstacle for individuals receiving income from pass-through entities. If your pass-through entity qualifies for the R&D tax credit as an eligible small business, and you personally have AMT, you may be able to offset the AMT using the R&D tax credit.

Contact the Credits & Accounting Methods team today to discuss your options!