Many manufacturers take advantage of the federal income tax credit for increasing research activities, more commonly referred to as the “R&D credit.” Enacted back in 1981, the R&D credit was a way for the federal government to reward companies based on their investment in developing new products and processes. The most common form of utilizing the credit is to take a non-refundable credit against income taxes paid at either the entity level or the owner level (for pass-through entities).
But what about the companies that, for any number of reasons, aren’t generating significant income tax liabilities? Is there any benefit for those companies? In fact, there is.
In the early years of a start-up, there is often quite a bit of expense and not very much revenue. After all, the company is spending significant amounts of capital to develop a product and bring it to market. Wages are paid and prototypes developed, all in the hope that a few years down the road, there will be a viable product that starts bringing in revenue. Much of this activity is exactly what Congress had in mind when enacting the credit; however, the problem is that because expenses exceed revenue, an income tax credit just doesn’t give a company in this situation much current benefit.
Beginning in 2015, however, the R&D credit was modified to allow for qualified small businesses to utilize a maximum of $250,000 annually to offset the company’s portion of the Social Security tax. By electing to claim the R&D credit against payroll taxes, rather than income taxes, a start-up company can reduce a significant portion of their payroll taxes and free up cash flow to invest in the project or the business at large. No more waiting around until the company is profitable to receive a windfall from its development efforts!
Meeting the definition of a “qualified small business” is relatively straight forward – a company’s gross receipts generally need to be under $5 million annually (based on a five-year average). Further, the payroll tax portion of the R&D credit can’t be utilized for more than five years.
If you’re a small business and think you might qualify for the payroll portion of the R&D credit, please reach out to your local Blue & Co. advisor.