How the New R&D Credit is Helping Small Businesses with AMT and Payroll Tax Offsets
AMT Tax Offset
The newly revamped R&D Tax Credit program, as enacted through the PATH Act, now permits eligible small businesses (ESB) to include the R&D credit in the calculation of the Alternative Minimum Tax (“AMT”) for tax years commencing after December 31, 2015.
An eligible small business for purposes of offsetting AMT is:
A corporation whose stock is not publicly traded, a partnership, or a sole proprietorship whose average annual gross receipts (net of returns & allowances) for the 3-tax-year period preceding the tax year of the credit claimed does not exceed $50 million.
If the business did not exist for the 3-year period prior to the claim, then the average annual gross receipts should be based on the period in which the business existed.
AMT removes nearly all deductions and credits in calculation of a truly alternative tax that is imposed on taxpayers who exceed certain statutory thresholds. Without deductions & credits, the affected taxpayers are exposed to a level of taxation that is higher than what would result from following the normal rules. The PATH Act allows the inclusion of the R&D tax credit in those calculations, and, as such, it is one of the few “safe harbors” against the effects of AMT.
Thus, this AMT modification assists small business owners who are currently subject to AMT to actually utilize the benefit of the R&D Tax Credit. Therefore, they can then use these tax savings to reinvest the saved tax dollars back into their businesses to strengthen R&D efforts and cultivate their companies.
In addition, partners and shareholders of LLC’s and SCorps can apply their share of the R&D credits, as passed through the K-1 distributions, to their personal returns if BOTH the entity and these individuals pass the gross receipts test described above. In some softwares, when tax preparers begin to complete the Schedule K-1, they are prompted to select or non-select whether, or not, the distribution satisfies the requirements of an ESB. Indicate affirmatively. This prompt may appear in different places in other softwares. Regardless, the R&D credit can assist these individuals with avoiding AMT in their personal returns.
Moreover, the amended R&D tax credit allows qualified start-ups to use the credit to offset the employer share of FICA taxes as discussed below.
Payroll Tax Offset
Previously, startups with no income tax liabilities could only carry forward R&D credits to a time that income taxes were owed. However, the new R&D tax credit now allows qualified small businesses to elect to use all or a portion of their R&D tax credit to offset the employer portion of payroll taxes, instead of waiting to use the credit against income taxes.
Highlights of the rules:
- Available for tax years beginning on or after January 1, 2016.
- Gross receipts cannot exceed $5 million in the year claimed & zero in all years preceding the four years prior to the year of claim (aka “the five years ending with the current year”). The law does not specify the threshold applicable to the four years preceding the current year, so certain, conservative assumptions must be made until clarity is provided.
- These companies can take a credit against the employer portion of FICA taxes only–other payroll taxes are excluded.
- Credits used are capped at the lesser of credits earned or $250,000 per year for five years.
To elucidate on the above, these companies can now take a credit against the employer’s portion of FICA taxes. The FICA tax is the Federal Insurance Contributions Act tax and is a United States federal payroll (or employment) tax imposed on both employees and employers to fund Social Security and Medicare. The former is derived at a rate of 6.2% of gross wages, while the latter is derived at a rate of 1.45% of gross wages, a total of 7.65% of gross wages. Employees’ paychecks are levied at these rates, and employers pay the same amounts. Only the employer portion is subject to offset.
In addition, there is a maximum credit capped at up to $250,000 per each eligible year for five years. The payroll tax offset is effective for 1/1/2016, but not available for 2015 or earlier periods. It is important to note that the total of payroll tax credit claimed does not decrease the amount of deductions permitted for payroll taxes on the tax returns. Furthermore, any unused credit may be carried forward to offset against future payroll tax liabilities.
A “Qualified Small Business” for purposes of the payroll tax credit election is described as a corporation or partnership with under $5 million in annual gross receipts and has no gross receipts preceding five years. Hence, this is particularly valuable for start-up companies, who majority of the time will produce R&D expenses but won’t have a taxable income and aren’t paying federal income taxes.
To provide further clarification, we’ve provided two examples:
DEVO, a small tech company founded in 2014, had acquired substantial R&D and payroll expenses in tax year 2015, however no revenue was produced. Since it worked at a loss, DEVO did not claim any R&D Tax Credit in 2015. Moreover, the small company expects 2016’s activities to be comparable with those of 2015.
DEVO’s 2016 Activity
|Business Form of the Taxpayer||C-Corporation|
|R&D Tax Credit Eligibility||$150,000|
|Payroll Tax Liability||$100,000|
Because of the PATH Act, DEVO should secure the $150,000 of R&D Tax Credit in 2016 and elect to offset it against the $100,000 of payroll tax liability and carry forward the remaining $50,000 to offset against future payroll tax liability.
DEVO’s 2017 Activity
|Business Form of the Taxpayer||C-Corporation|
|R&D Tax Credit Eligibility||$200,000|
|Payroll Tax Liability||$150,000|
In 2017, DEVO started to make a profit. DEVO will apply their $200,000 R&D Tax Credit against their income taxes, leaving $100,000 of the credit remaining. Under the PATH ACT, this remaining credit will be used to offset $100,000 of their $150,000 payroll tax liability.
How To Apply
The IRS recently released Notice 2017-23, which provides interim guidance regarding how eligible businesses can elect the payroll tax offset. To apply, the business must complete and attach Form 6765, Credit for Increasing Research to their income tax return. However, if a business has already filed this tax season, they can still take advantage of the new option. Due to a special rule for the 2016 tax year, businesses that did not originally choose the option can still do so by completing an amended return by December 31, 2017.
To be eligible for the extension, the company must indicate on the top of Form 6765 “FILED PURSUANT TO NOTICE 2017-23,” or attach a statement to its Form 6765 that the form is filed pursuant to Notice 2017-23.
Once the option has been selected, businesses can claim the payroll tax credit by filling out Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities and attaching it to their payroll tax return. The taxpayer filing the employment tax return claiming the credit must provide on Form 8974 the EIN used on the Form 6765 reflecting the election.
For further information on claiming the Payroll Tax Offset or the AMT Tax Offset for small businesses, contact a Swanson Reed tax specialist today.