Claim R&D Credits Against Your Federal Payroll Withholding

By Carli McDonald, partner-in-charge of R&D Tax Credit Services, and Olivia Backs, tax associate

Last year, Congress re-vamped its tax credit policies by permanently extending the R&D Tax Credit through the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act”). This act created several substantial opportunities previously unutilized by many “startup” companies in obtaining Research & Development (“R&D”) Tax Credits.

Traditional startup companies typically don’t have taxable income for several years. Even though these companies are not generating taxable income, they still spend considerable amounts of money on R&D, with a majority stemming from wages subject to payroll tax. This previously led to unused R&D Tax Credits that were carried forward to future taxable years until companies began making a profit.

What’s next for “small businesses”?

Qualified small businesses can now take advantage of the credit’s lucrative tax benefits by applying it against payroll withholding. Effective for all tax years beginning after Dec. 31, 2015, any qualified small business may elect to apply their R&D Credits against payroll tax liability up to $250,000 per year. To be considered a qualified small business, a company must meet the following criteria:

  1. Less than $5 million in gross receipts for the current tax year; and
  2. Gross receipts for no more than 5 years, including the current tax year.

Your company can apply the credit against the first quarter following the filing of its federal tax return. For example, a qualified small business with $2 million in gross receipts in 2016 can apply their 2016 R&D Tax Credit toward their payroll tax liability up to $250,000 per year on the company’s 2017 quarterly payroll withholding on IRS Form 941.

What’s next for facilitating the new credit claiming process?

For companies to start taking advantage of their R&D Credits, they must:

  • Prepare and file the following IRS Forms with the company annual income tax return: Form 6765, Credit for Increasing Research Activities and Form 3800, General Business Credit; and
  • Prepare and file IRS Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, which is attached to IRS Form 941 quarterly.

We also recommend getting an R&D study done by Aprio’s R&D team.

The IRS has officially released the 2016 Forms 6765 and 3800, and will release the current Forms 8974 and 941 shortly. As a final reminder, it is imperative companies document their qualifying R&D activities regardless of taxable income, as the credit must be calculated with a filed federal return before claiming the credits against payroll tax.

For next steps, updates on Form releases or evaluating whether your company qualifies for an R&D Tax Credit, contact Carli McDonald, partner-in-charge of R&D Tax Credit Services, at 770-353-2772 or carli.mcdonald@aprio.com for more information.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

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