Startups can benefit from the Federal Research & Development Credit this year and reduce their quarterly tax liabilities with a Payroll Offset of up to $250,000 this year!
We know how beneficial the Research and Development Credit (R&D Tax Credit) is when reducing taxable income for profitable companies, as well as how strategic it can be to “bank” the credit for future use when a company is not profitable but anticipates a large tax liability within the next couple of years, but what is this talk about using the credit more immediately as a reduction or offset to a company’s FICA liability?
A startup that is not yet profitable can benefit from a cash injection when they reduce their employer payroll taxes with R&D tax credits.
What is the credit again?
The R&D Tax Credit is a general business tax credit under IRC 41 available to eligible innovative companies that perform a multitude of qualified activities, such as developing or improving products, processes, techniques, or software in a variety of industries related to engineering, computer science, hard sciences and others. Companies might be surprised by how many industries actually qualify!
What is changing? What do you mean by payroll offset?
Since the incentive became permanent under The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) in December 2015, small and medium-size businesses have had new opportunities in how to more effectively apply and utilize the credit. Under the permanent extension, eligible businesses with gross receipts of less than $5 million in a year can take the credit (up to $250,000), against their employer FICA Social Security tax liabilities at 6.2% of total payroll. If they choose, employers can now claim the credit on the employer’s quarterly Form 941, rather than on their business tax returns, using Form 3800.
Is it more complicated to claim now?
It can seem so because there are now extra steps, however, the new option to claim the credit still follows traditional steps. Let’s break it down:
- In order to apply credits to payroll liabilities, companies need to first calculate the tax credit and complete Form 6765, Section D. They do so by working with a specialty R&D credit service provider that walks their accountant through where to attach to their corporate tax return.
- Next, the IRS has introduced a new “connecting” form that links the 6765 to the Quarterly 941. The new Form 8974 , must be filed and reported with the employer’s Quarterly Form 941 for Payroll Offset to successfully occur. It is important to note that employers are not able to claim the credit using this method until the business income tax return for the tax year is filed, and then will make the application with their payroll provider.
- Last, amounts from 8974 transfer to Form 941 and the offset begins until credits are exhausted.
- Calculate tax credit using Form 6765, Section D.
- Take amounts from Form 6765 to help complete Form 8974.
- Transfer amounts from Form 8974 onto Form 941. Payroll offset occurs and cash is freed up for your growing business!
How do I get started?
While the process can seem taxing, it doesn’t have to be! While everyone is new to this recently enacted application, the basis for the credit has remained the same. Eligible companies are best to seek a specialty provider with extensive experience in claiming and substantiating the R&D credit for companies and their CPAs for inclusion on their tax returns this upcoming filing. It is wise to also notify your payroll provider that you are planning to bring credits to them for the payroll offset to occur and seamless as possible.