Did your small business recently file an extension for its 2016 income tax return? If so, then it’s not too late to take advantage of the Research Tax Credit (R&D Tax Credit), available for taxpayers that make investments in developing or improving their products, manufacturing processes, or software. Many sizable R&D Tax Credit opportunities, however, go unnoticed or unclaimed because taxpayers are often uncertain whether their activities qualify and the rules for calculating the credit can be cumbersome and complicated.
The R&D Tax Credit is based most commonly on Qualified Research Expenditures (“QREs”), i.e., certain wage, contractor, supply, and computer/cloud-time-sharing expenses paid or incurred generally for product, process, and software-development and improvement activities. The PATH Act retroactively and permanently extended the R&D Tax Credit for 2015 and beyond. In addition to being made permanent, for taxable years beginning after December 31, 2015, the R&D Tax Credit now has two added benefits, discussed herein.
Application of the R&D Tax Credit Against AMT
Eligible small businesses (those that are privately held and with $50 million or less in average gross receipts for the three preceding taxable years) may utilize the R&D Tax Credit against their AMT. Historically, businesses could only use the R&D Tax Credit to offset ordinary tax liability and only to the extent this liability exceeded their AMT, with one exception to this rule in 2010. For a partnership or S corporation, the gross receipts test must be met by both the entity and by the partner or shareholder for the tax year.
Application of the R&D Tax Credit Against Employer’s Payroll Tax
Additionally, startup companies (those with annual gross receipts of less than $5 million for the current taxable year and in each of the four proceeding tax years and no gross receipts for any tax year before the five taxable years ending with the current tax year) may utilize the R&D Tax Credit against employer’s payroll tax up to $250,000 annually for five years. The gross receipts test applies on a controlled group basis for corporations and partnerships. Other business entities, such as sole proprietorships, can be an eligible small business, but the aggregate gross receipts received from all trades or business carried on by the person must be taken into account. Note, in the case of a partnership or S corporation, this election is made at the entity level.
This is an important added benefit, as start-up companies investing in new technologies often do not pay income taxes. Research credits for which the taxpayer makes the payroll tax election on its annual income tax return can be applied only against the employer’s old-age, survivors and disability liability (the OASDI) or “social security” portion of FICA taxes. The payroll credit is required to be claimed for the first calendar quarter beginning after the date on which the qualified small business files its income tax return for the tax year. A taxpayer making the election for tax year 2016 who timely files its income tax return in September 2017 would be able to use the credit against its payroll tax liability for the fourth quarter of 2017. In 2016, the IRS released in draft Form 8974 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities) which must be prepared to determine the amount of research credit that can be used as a payroll tax credit on a Form 941. A completed Form 8974 is expected to be attached to the Form 941 for each quarter the credit is used. As of the date of this article, the IRS has not issued a final Form 8974 or final related guidance and procedures. We will provide an update when the information becomes available.
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