Until recently, a small business or startup may not have qualified to take the research tax credit if it had little or no income tax liability. Prior to 2016, the research credit could only be taken against a taxpayer’s income tax liability.
Thanks to the Protecting Americans from Tax Hikes Act (PATH) of 2015, eligible a small business may be able to apply up to $250,000 of its research credit against its payroll tax credit for any taxable year beginning after December 31, 2015.
The research tax credit allows companies to deduct expenses related to developing new processes, efficiencies, or initiatives that eliminate uncertainty within the business. To qualify for the research tax credit, your activities must be:
- Technical in nature – the R&D must be scientific and based on the principals of engineering. physics, biology, or computer science.
- Permitted in purpose – R&D projects for a new or improved aspect of the business such as processes, functions, products, quality assurance, and substantial reductions in costs.
- Involve a process of experimentation – qualified research that involves trial and error and an evaluation of alternatives to achieve a desire result which was previously uncertain. Documentation on the hypothesis and testing procedures are required by the IRS.
To qualify for the payroll tax credit, a small business must have less than $5 million in gross receipts in the taxable year and zero gross receipts for any tax year before the 5-tax-year period ending with the taxable year. For example, if the company wants to take the payroll tax credit for research activities in the 2016 taxable year, it could not have had any gross receipts before taxable year 2012. If, however the business did have gross receipts in taxable year 2012, it would not be a qualified small business for taxable year 2017, regardless of its gross receipts in 2017. The IRS defines gross receipts as the total amounts the organization received from all sources during its annual accounting period, without subtracting any costs or expenses.
A tax-exempt organization is not considered as a qualified small business even if they satisfy the qualification requirements.
A small business can claim the payroll tax credit by filing for Qualified Small Business Payroll Tax Credit for Increasing Research Activities (Form 8974) with a payroll tax return such as the Employer’s Quarterly Federal Tax Return (Form 941). An eligible small business may elect to amend a return to take the payroll tax credit for any taxable year beginning after December 31, 2015 on or before December 31, 2017.
The U.S. Treasury Department and IRS issued Notice 2017-23 on March 30, 2017 to provide interim guidance for qualified small businesses filing their 2016 federal income tax return on or before April 18, 2017. This notice provides more details to small business owners.
Please call us at 610.828.1900 or contact either Michael Sexton, CPA, CCIFP, Director – Tax Services at Michael.Sexton@MCC-CPAs.com or me at Marty.McCarthy@MCC-CPAs.com if you have questions. We are always happy to help.