Federal R&D Payroll Tax Offset
The federal R&D payroll tax offset provision allows a start-up company to claim credit against their payroll taxes up to $250,000. The effective date is for tax years beginning after December 31, 2015. Under IRC Section 41(h): a start-up company, also called a “qualified small business” (QSB), can elect to use their federal R&D credit to offset their employer paid payroll taxes starting in tax years after December 31, 2015.
A “qualified small business” is defined as a) a business with less than $5 million in “gross receipts” in the credit year (e.g. 2016) and b) has no “gross receipts” for any taxable year preceding the 5-taxable-year period ending with the credit year. (e.g. no gross receipts in 2011 or earlier).
The payroll tax is the portion of the employer paid social security tax of FICA (6.2%), also called Old-Age, Survivors, and Disability Insurance (OASDI). In 2017, the limit on the social security portion of the tax is capped at $127,200 of an employee’s annual earnings. Note: the credit cannot be used to reduce Medicare taxes.
Taxpayers have to claim the federal R&D tax credit on the income tax return and then can use all (or a portion thereof) of the credits the following quarter(s) to offset payroll taxes. Any unused credits can be carried forward to the next year.
On March 30, 2017, the Treasury and IRS released interim guidance on qualified small businesses making the payroll tax credit election. Some of the key areas addressed include:
- The definition of “gross receipts”;
- Aggregation rules apply for all members of a controlled group;
- Tax exempt organizations are NOT a QSB;
- Defined the time and manner of the election; and
- Ability to make a payroll tax credit election on an amended tax return on or before December 31, 2015.
Taxpayers need to be careful in determining what is gross receipts under this provision. Per notice 2017-23, “gross receipts” are defined under IRC sections 448(c)(3) and 1.448-1T(f)(2)iii and iv of the income tax regulations:
- Total sales (minus returns and allowances);
- Investment income (from incidental and outside sources);
- Interest, dividends, rents, royalties, annuities;
- Grant income;
- Gross receipts are not reduced by the cost of goods sold; and
- No “de minimis” rule (e.g. $100).
In order to claim the federal payroll tax credit you must complete the following:
- Complete Federal Form 6765 (Credit for Increasing Research Activities) on the income tax return;
- In Section D (on Form 6765), elect the payroll tax credit option and chose what amount of the credit you would like to offset payroll taxes. Note: you can elect to have some of the R&D credit offset any income tax liability due for that tax year;
- Taxpayer timely files their income tax return (including any extension);
- The next calendar quarter, the taxpayer can start reducing their payroll tax payment by the amount of the credit when they file Form 941 “Employer’s Quarterly Federal Tax Return”.