Applying Research Credit Against Payroll Taxes

Have you thought about claiming the research tax credit for your small business? If you earn any research tax credits during the year, you can elect to apply them against your payroll taxes rather than your income tax. This tax election might sway businesses to tackle research activities more frequently. However, if you are currently or planning to engage in research activities without considering tax consequences, know that tax relief might be available for you.

Here are the answers to commonly asked questions about this option:

What is the importance of the payroll tax election?

Most new enterprises don’t pay income taxes and won’t for several years, even if they have a book profit or cash flow. Due to this, there’s no amount against which research credit can be applied. However, any wage-paying organization has payroll tax liabilities. The election is a chance to receive instantaneous benefits from the research credits that a business earns. Each dollar of credit-eligible expenditure could result in a 10-cent tax credit. Even the smallest amount of tax credit can significantly aid an organization in its start-up phase.

Which businesses are eligible for the election? 

There are two requirements to qualify for the election as a taxpayer. First, a company must have gross receipts for the year that amount to less than five million dollars. Secondly, it must be no more than five years after the period where the organization had no receipts. This timeframe is considered the start-up period. Personal income such as salary or investments is not needed. This means the gross receipts from the small business are the only ones an individual taxpayer needs to consider. It is also important to understand that neither an individual nor an enterprise can make the election more than six years in a row.

What are the limits on the election?

The amount of research credit for the payroll tax election cannot surpass $250,000 every year. In addition, an individual cannot make the election for research credits that they could use to decrease income tax liabilities. Another crucial factor is that research credits for the payroll tax election can only apply against an employer’s elderly age and survivors and disability liability (the OASDI or Social Security part of FICA taxes). Therefore, the election can’t be used to lower either the employer’s liability for FICA taxes regarding Medicare or any FICA taxes that the employer remits to the government on behalf of employees.

This article only covers the basics of the payroll tax election. Recognizing and proving expenses that are eligible for the research credit is a complicated process and can be confusing. For more information, contact us.