Research Credit May Now Be Used to Offset Certain Payroll Taxes

We have an important tax update for our clients who claim, or are considering claiming, the research credit. Starting with tax years beginning on or after January 1, 2016, qualified small businesses may elect to apply some or all of their research and development tax credits against payroll taxes. For qualified small businesses that are engaged in or are planning to engage in research activities, the below discussion may serve to inform you of some future tax relief.

Why is the election important?

Many new businesses, even if they have some cash flow or even net positive cash flow and/or a book profit, pay no income taxes and will not for some time. Thus, there is no amount of research credit that can be applied against income taxes. On the other hand, any wage-paying business, even a new one, has payroll tax liabilities. The payroll tax election is an opportunity to get immediate use out of the research credits for qualified small businesses. Every dollar of credit-eligible expenditure can result in as much as a 10 cent tax credit. This is a big help in the start-up phase of a business, often when help is needed most.

What businesses are eligible?

To qualify for the election, a taxpayer (1) must have gross receipts less than $5 million for the election year and (2) did not have gross receipts for any tax year preceding the five tax-year period ending with the tax year. Note that qualified small businesses cannot make the election for more than five years.

Limits on the election

Research credits for which the taxpayer makes the payroll tax election can be applied only against the employer portion of social security taxes. The credits are allowed for the first calendar quarter which begins after the date on which the taxpayer files its income tax return and makes the election. The credit cannot exceed the social security tax liability for a calendar quarter.

The amount of any unused credit can be carried to the succeeding calendar quarter. The amount of research credit for which the election can be made is limited to $250,000 per year. Note that a qualified small business that is a C Corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a taxpayer cannot make the election for research credits that the taxpayer can use to reduce current or past income tax liabilities.

Identifying and substantiating expenses eligible for the research credit itself is a complex area. We have extensive experience assisting clients with navigating the complexities of the research credit. We encourage you to reach out to us to further discuss this unique law change and see if it would be a useful election for your business. We are available at 925.271.8700 or at