How R&D Tax Credits Can Offset Payroll Taxes for Startups

Decisions that you make at the time of the filing of the income tax returns can save you cash. It is important that when you file your income tax returns, you make sure to calculate the R&D tax credit if you qualify. In this video, I will outline how the R&D tax credit works in your favor if you qualify. First off, let's talk about the R&D credit. The R&D credit under Internal Revenue Code Section 41 allows businesses to claim a tax credit for increasing research activities. This credit is to encourage companies to invest in innovation and technological advancements.

Who is eligible for this credit? To qualify for the R&D credit, your activities must meet the following four criteria. Your company's activity must be technological in nature, and based on science such as biology, chemistry, computer science, or engineering. The intent must be to improve something. This could be products, processes, software, techniques, formulas, or inventions. Elimination of uncertainty. The research must aim to eliminate uncertainty regarding the development, or improvement, or a product, or a process. There must be experimentation. Substantially, all activities must involve experimentation to resolve technical uncertainties.

So if your activities qualify for the R&D tax credit, you should be claiming the credit on your tax return. Now that your startup has qualified the R&D tax credit, let's discuss how you can use the credit to offset payroll taxes. The Protecting Americans from Tax Hikes or PATH Act of 2015 allows qualified small businesses, QSBs, to elect to apply a portion of the R&D credit against their payroll tax liability. This is particularly beneficial for startups with little or no income tax liability.

Steps to claim the payroll tax credit. One, determine eligibility. Ensure your business qualifies as a QSB. Generally, a QSB is a corporation, partnership, or individual with gross receipts of less than $5 million for the taxable year, and no gross receipts for any taxable year preceding the five taxable year period ending with the taxable year. Calculate the credit. Complete Form 6765 Credit for Increasing Research Activities to calculate your R&D credit. In Section D, of the form elect the payroll tax credit option.

File the election. Attach Form 6765 to your timely filed, including extensions income tax returns for the taxable year to which the election applies. Note that the election cannot be made on an amended return. Step four, claim the credit. After filing your income tax return. You can claim the payroll tax credit on your employment tax return for the first quarter that begins after you file the income tax return. Complete Form 8974, Qualify Small Business Payroll Tax Credit for Increasing Research Activities and attach it to your employment tax return such as the Form 941. This way, the R&D tax credit can be used to offset payroll taxes.

The Inflation Reduction Act of 2022 increased the maximum amount of the payroll tax credit from $250,000 to $500,000 for tax years beginning after December 31st, 2022. This enhancement provides even greater benefits for startups investing in R&D. Utilizing the R&D tax credit to offset your payroll taxes can significantly impact your cash flow. By following the steps that I've outlined, you too can benefit from this valuable tax incentive. Please reach out to the EisnerAmper team if you have any questions.