Startups Can Use Research Credit to Offset Payroll Taxes

• Published date: 01 January 2017
• Date: 01 January 2017
• Author: Shirley Dennis‐Escoffier
• DOI: http://doi.org/10.1002/jcaf.22248

D

e

p

a

r

t

m

e

n

t

s

IRS

108

© 2017 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

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.

BACKGROUND

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.

QUALIFIED SMALL BUSINESS

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