Qualified small businesses with gross receipts of less than $5 million can now take advantage of the Federal Research & Development (R&D) tax credit by applying it against the employer’s share of Social Security employment tax liabilities.

More about the credit

The employer payroll tax offset will be available for qualified R&D expenses incurred in 2016. This new payroll tax offset allows companies to receive a benefit for their research activities for up to a maximum of $250,000 in credits per year. This also allows those qualified small businesses who have not yet begun incurring an income tax liability to begin saving money right away.

What is a ‘qualified small business’?

The new payroll tax offset is available in 2016 only to companies that have:

• Less than $5 million in gross receipts in 2016
• Gross receipts for five years or less. A company isn’t eligible if it generated gross receipts prior to 2012.
• Qualifying research activities and expenditures.

So, what is a ‘qualified research expense’ or QRE?

Code section 41 and 174 define QREs as expenses which pass this four-part test:

1. Eliminate uncertainty
2. Involve a process of experimentation
3. Are technological in nature
4. Are for a permitted purpose

Types of expenses that can qualify included wages paid to an employee for qualified services, any supplies used in the conduct of qualified research, and 65% of any amount paid to any outside person or vendor for qualified research performed on behalf of the company.

How does a business apply for the credit?

A taxpayer may make the election by specifying the amount on or before the due date (including extensions) of the income tax return for the tax year the credits are generated. The election is made on Form 6765, Credit for Increasing Research Activities, and attached to their business income tax return. The credit can then be used against the qualified small business’s social security employer tax liability on wages paid for the first calendar quarter beginning after the date on which the return was filed. Any excess credit not used to offset the employer’s social security tax during the quarter will be carried forward to the next calendar quarter.

But, isn’t it too late to apply?

While the election must be made on a timely filed return, the IRS has issued guidance allowing a qualified small business that did not originally choose the credit in 2016 to make the election by filing an amended return on or before December 31, 2017.

For more information on applying for the payroll tax credit, reach out to our Tax Services Team.