The research and development (R&D) credit is a substantial tax break provided to eligible businesses. Claiming the credit requires intricate computations, which we can handle for you. However, in addition to the credit itself, two elements are particularly beneficial to small businesses:

1. Small firms with gross receipts of less than $50 million are eligible for the credit. You can use that credit to offset the alternative minimum tax (AMT) obligation.
2. Even certain smaller start-up enterprises can use the credit to offset their Social Security payroll tax liability.

Let’s look at the second feature now. Subject to certain limitations, you can choose to apply all or part of any research tax credit obtained against your payroll taxes rather than your income taxes. This payroll tax option may persuade you to start or expand your research efforts. But, on the other hand, if you’re doing research without thinking about the tax implications — or expecting to do so — you might be eligible for some tax relief.

Why the election is important

Even if they have some cash flow, or even net positive cash flow and/or a book profit, many new enterprises do not pay income taxes and will not for a long time. As a result, you cannot apply business credits, including the research credit, to any sum. On the other hand, payroll taxes are owed by every wage-paying business, even if it is brand new. As a result, using the payroll tax election allows you to put your research credits to immediate use. Moreover, because every dollar of credit-eligible spending can result in a 10-cent tax credit, it’s a tremendous aid in the early stages of a company’s life — when it’s most needed.

Businesses eligible for the research tax credit

To be eligible, a taxpayer must have gross receipts of less than $5 million for the election year. They must also be without receipts for no more than five years (the start-up period).

Individual taxpayers’ gross receipts from their enterprises are the only ones considered while calculating these calculations. That does not include salary, investment income, and other sources of income. It’s also worth noting that no business or individual can run for office for more than six years in succession.

Limits on the payroll tax election

The research credit for which the taxpayer makes the payroll tax election only applies to the Social Security portion of FICA taxes. So you cannot use the credit to reduce the employer’s liability for the “Medicare” part of FICA taxes. Additionally, you cannot use the credit to reduce any other FICA taxes withheld and remitted on behalf of employees.

The maximum research credit amount for an election made per year is $250,000. Also, an individual or C corporation can only make the election for those research credits that would otherwise be carried forward if no election was made. In other words, a C company cannot decide to take advantage of using the research credit to offset current or previous income tax liabilities.

As mentioned above, those are only the fundamentals of the payroll tax election. Keep in mind that identifying and substantiating research credit-eligible expenses is a difficult task in and of itself. Please contact our RRBB accountants and advisors to see if you qualify for the payroll tax election or the research tax credit.

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