Most startup businesses are unlikely to have any federal income tax liability in the early years, making research and development (R&D) tax credits less valuable to them under the traditional approach.
However, with the recent tax provision changes to the R&D credit in December 2015, a qualifying small business taxpayer may now use federal R&D tax credits against their federal payroll tax liability.
In fact, upon meeting the criteria for a Qualified Small Business (QSB), startups may improve cash flow by up to $250,000 a year by claiming federal R&D tax credits under this new provision.QSBs are defined by the following:
- A corporation/partnership that’s not a tax-exempt company under Code Sec. 501
- Zero gross receipts prior to the five-tax-year period ending with the credit year
- Has current gross receipts that are less than $5 million for the credit year
R&D Tax Credit Benefits For Your Startup: The Details
To apply the R&D tax credit against your payroll tax, an election must be made on a timely filed federal income tax return including extensions, at the entity level in the case of a partnership or S corporation. The effective date is for taxable years after December 31, 2015.
The election, with IRS consent, determines what portion of the R&D tax credit is allowable to offset your QSB’s payroll tax (as opposed to offsetting your federal income tax liability). The allocated portion of the R&D tax credit is applied and reported on your quarterly payroll tax return.
An added benefit is that any portion of the R&D tax credits you don’t use may be carried forward up to 20 years, and may be used against your business’s income tax liability once the business becomes profitable, making it a win-win situation for taxpayers.
Tips To Ensure Your Startup Captures R&D Tax CreditsConduct a complete and comprehensive R&D study each year to fully support the credits identified and reported. Since R&D tax credits are substantial, claims draw sufficient attention and review by the IRS.
To avoid losing any credits, perform an analysis to determine the proper amount of payroll allocation. The analysis should consider your startup’s current and future federal tax position.
Incorporate a sophisticated technology supported process to efficiently interview key personnel and capture the required documentation to support your credit claims. This helps minimize disruptions to your daily operations.
The Provision That Should Excite Every Entrepreneur
As a qualifying small business taxpayer, you now have an important tax benefit to help your small business with innovation. Keep in mind, the R&D tax credit covers applied research in a wide range of industries.
If this is your first time seeking tax benefits for research and development, it’s especially important to have the right support for following proper protocol when submitting your claims to the IRS. That’s why it’s highly recommended you partner with a tax consultant that is experienced in R&D to avoid any roadblocks or penalties on your way to claiming this lucrative credit.
Ready to learn how R&D tax credits can support your business? Download your complimentary, educational guide.