Did you know your company may be able to use research and experimentation (R&E) tax credits to offset payroll taxes? The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) made it possible for qualified small businesses with research tax credits to offset the employer portion of federal Social Security taxes up to $250,000 per year for up to five tax years.
The benefits of the payroll offset strategy are illustrated in an R&E study McGuire Sponsel completed for a startup software company. The three-year-old company was operating at a loss, so the $145,000 in effective tax credits generated from $2 million in qualified research expenditures could not be used to offset income tax liability in 2017. Utilizing the new PATH Act regulations, the client was able to use all of its earned R&E credits to offset payroll taxes.
The payroll offset election is available to companies with less than $5 million in gross receipts for the current tax year and no gross receipts for any tax year before the five-year tax period ending with the current tax year. Returns and allowances are subtracted, and interest income is included in gross receipt totals. For example, a taxpayer filing a 2018 tax return would be eligible if gross receipts in 2018 were less than $5 million and there were no gross receipts in or before 2013.
To use this strategy, taxpayers would select the small business payroll tax credit election and amount on Form 6765 (Credit for Increasing Research Activities) when filing the tax return. The elected credit amount is claimed against payroll tax liability on Form 941 (Employer’s Quarterly Federal Tax Return) for the quarter beginning after the tax return is filed. Form 8974 (Qualified Business Payroll Tax Credit for Increasing Research Activities) is used to calculate the amount to be applied to payroll tax liabilities and must be attached to Form 941.
For example, a taxpayer filing a 2018 tax return by March 15, 2019 (first quarter), would claim the payroll tax credit on Forms 941 and 8974 for the second quarter of 2019. By April 15, 2019 (second quarter), the taxpayer would claim the offset for the third quarter of 2019. If a company utilizes a professional employer organization (PEO) to run its payroll, the PEO will be responsible for filing Forms 941 and 8974. It is important to note the payroll offset amount cannot be revoked once elected and any credits that cannot be used during a quarter will be carried forward to future quarters.
If your startup business is currently operating at a loss and has little or no income tax liability, the payroll offset may be a favorable option to realize the benefits of your research credits straightaway. Contact McGuire Sponsel today to see how your company can benefit from using the R&E credit to offset payroll taxes.