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Is your company eligible for the Research & Development tax credit but has no income? Consider offsetting payroll tax instead.

Jul 31, 2019

Research and development (R&D) tax credits have been utilized by taxpayers since the 1980s to generate income tax savings. 

In simplest terms, $1 of tax credit offsets $1 of income tax liability — quite a lucrative incentive. However, in the early years of development, some startup companies could not immediately benefit from claiming an R&D credit because they were not generating revenue, and thus not paying income tax. That has now changed for eligible small businesses.  

The Protecting Americans from Tax Hikes (PATH) Act of 2015 allows qualified small businesses to use the federal R&D tax credit to offset the employer portion of the social security tax. 

The R&D credit payroll tax offset

Beginning in 2016, irrespective of whether or not a taxpayer is generating revenue, as long as the company has paid employees, there is another means to utilizing the R&D tax credit — the payroll tax credit election.

Note that the payroll tax election offsets the employer portion of the social security tax; it does not offset Medicare tax or the employee portion of social security tax. 

Who is eligible?

A taxpayer is considered a qualified small business and eligible for the payroll tax offset if they meet two qualifications. They must have 1) gross receipts less than $5 million in the current tax year, and 2) no gross receipts for any tax year before the five tax years ending with the current tax year. 

The gross receipts definition to determine eligibility includes total sales (net of returns and allowances), all amounts received for services, and any income from investments and incidentals. Included in this definition would be any interest, dividends, rents and royalties. 

Organizational structure must be considered in determining eligibility. All members of a controlled group for the tax year are treated as single taxpayer for purposes of applying the gross receipt requirements.

How much can you elect?

While there is no limit to the research and development tax credit you can claim, there is a limit on the payroll tax offset you can elect. The maximum annual payroll tax offset a taxpayer can elect is $250,000. Any current-year research credits claimed in excess of the $250,000 maximum remain available to offset income tax liability. 

If the company is a part of a controlled group, the control group is treated as single taxpayer for purposes of the $250,000 limit. An allocation of the $250,000 is made to each control group member based on each member’s qualified research expenses for the current tax year.

Is this still an opportunity for 2018?

The payroll tax offset election must be made on an originally filed return, including extension. If your company already filed the 2018 income tax return, the next opportunity to consider this election is 2019. However, if the company has not yet filed the 2018 income tax return, then there is still an opportunity to consider this election. For a controlled group, each member can separately consider making the election.

When do you receive the offset?

If the payroll offset election is made, you can begin to benefit from the payroll tax offset in the first calendar quarter after filing your income tax return.  

As an example, the company income tax return with the payroll credit election is filed on March 1, 2019 (first calendar quarter). The first calendar quarter after the income tax return is filed is second quarter (April, May and June 2019). The elected payroll credit offset can be applied to taxes due in relation to the second quarter. Any payroll credit offset not used in the second quarter can be carried forward to future quarters.  

Should you make the election?

Is your company eligible? Is the payroll tax offset credit the most beneficial circumstance for the company? Or should the R&D credit remain as a credit carryforward to offset future tax liability? How much should you elect? 

These are all very valid questions. An accounting firm like Wipfli goes through each of these scenarios with you to evaluate your unique situation and find the best solution for you. 

Are you eligible for the R&D credit payroll tax offset? Contact Wipfli to find out, and learn more about our R&D tax credit services here.


Christina Schultz, CPA
Senior Manager, Tax
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