Startups Can Use Research Credit to Offset Payroll Taxes

Published date01 January 2017
Date01 January 2017
AuthorShirley Dennis‐Escoffier
© 2017 Wiley Periodicals, Inc.
Published online in Wiley Online Library (
DOI 10.1002/jcaf.22248
Startups Can Use Research Credit
to Offset Payroll Taxes
Shirley Dennis-Escoffier
The research credit was cre-
ated as a financial incentive to
encourage innovative businesses
to increase their spending on
research and development of
new technologies and products.
Prior to 2016, the credit only
provided an immediate benefit
to businesses that were profit-
able and incurred an income
tax liability that could be
reduced by the credit. Although
the unused credit could be car-
ried forward to future years,
startup companies that needed
the savings immediately had
no way to access it. That has
now changed. Beginning in
2017, eligible small businesses
can use their research credits to
offset some of their payroll tax
liability. This will be of greatest
benefit to startups that could
not otherwise take advantage
of the research credit.
The research tax credit
has resulted in a tax savings
for many businesses since
it was first enacted in 1981.
Over the years, it has been
allowed to expire and then
been retroactively reinstated.
However, a continuing limita-
tion for many startup busi-
nesses is that they had no
income tax liability against
which to offset the credit. They
could only carry the unused
credit forward to use in future
years when they finally had tax-
able profits. Owners of startups
argued that they needed a way
to use the tax benefit from the
research credit in their early
years when the need to gener-
ate positive cash flow is greatest
and not be forced to wait until
future years.
In December 2015, Con-
gress passed the Protecting
Americans from Tax Hikes
Act, which retroactively rein-
stated and made permanent
the research credit for qualified
research expenses. The law also
added two tax benefits targeted
at small businesses. First, small
businesses with average annual
gross receipts of $50 million or
less will now be allowed to off-
set their alternative minimum
tax (AMT) liability with the
research credit. Second, startup
companies with gross receipts
of less than $5 million will be
allowed to elect to apply up
to $250,000 of their research
credit against the employer’s
share of Social Security taxes
instead of their income tax
liability. It is the second provi-
sion that has caught the atten-
tion of startups and is the focus
of this article.
A qualified small business
is a corporation (including an
S corporation) or partnership
that (1) had gross receipts of
less than $5 million for the
taxable year and (2) did not
have any gross receipts in any
tax years prior to the five-tax-
year period that ends with
the tax year of the election.
This means that a corporation
making this election for 2016
(the first year available) must
have gross receipts of less than
$5 million for 2016 and must
not have had any gross receipts
in a tax year before 2012.
Example 1: Alpha, a
calendar-year corpo-
ration, has $4.9 mil-
lion of gross receipts

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