The research and development (R&D) tax credit has a long history of providing businesses with incentives to invest in innovation. The Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently extended the income tax credit and further expanded the benefits of the credit to include up to $250,000 of payroll tax offset annually for eligible businesses. With the passage of the Inflation Reduction Act (IRA) in August 2022, qualifying new businesses and startups have even more opportunity to reduce tax, as the IRA doubles the amount that can offset payroll taxes, totaling up to $2.5 million over five years.
How can companies benefit from the R&D payroll tax credit?
Companies investing in innovation and R&D may be eligible to reduce tax obligations and offset the costs of bringing new products to market. With tax savings around 4–7% of qualified research expenses, the R&D tax credit is a worthy consideration. Qualifying expenses, including wages, contractor expenses, and supplies, can add up to significant savings.
Many startup companies and small businesses think they can’t benefit from the R&D tax credit due to operating losses or alternative minimum tax (AMT) limitations. However, these provisions were created with the intent to increase the number of startups and small to midsized businesses that can benefit from the credit.
The R&D payroll tax credit benefits new businesses
The R&D payroll tax credit is a great tax-savings opportunity for new businesses that have yet to generate taxable income. Unlike the traditional R&D credit, which can only offset income tax, the R&D payroll tax offset is available to startups with under $5 million in current-year gross receipts, and that have had gross receipts for no more than five years. For example, a startup tech company generates a $25,000 research credit and has an estimated FICA liability of $30,000 for the year. Under the new legislation, they can now use their $25,000 R&D tax credit to reduce their FICA liability from $30,000 to $5,000.
Another consideration for owners of pass-through companies (partnerships and S corporations) is that AMT may limit the ability to use the R&D income tax credits generated. However, for businesses with an average of $50 million or less for the prior three years’ gross receipts, the R&D tax credit can also offset this AMT liability. This provision provides small businesses with an increased ability to reinvest in their companies to further innovation and new product development.
There are planning opportunities and risks involved in determining any R&D tax credit, including addressing IRS documentation requirements, applying the related-party aggregation rules, and assessing options to maximize the credit. To learn more about how your company might benefit from provisions of the research credit rules, feel free to contact us.
