Research credit can offset a small business’s payroll taxes

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Does your small business engage in qualified research activities? If so, you may be eligible for a research tax credit that you can use to offset your federal payroll tax bill.

This relatively new privilege allows the research credit to benefit small businesses that may not generate enough taxable income to use the credit to offset their federal income tax bills, such as those that are still in the unprofitable start-up phase where they owe little or no federal income tax.

QSB status

Under the Protecting Americans from Tax Hikes Act of 2015, a qualified small business (QSB) can elect to use up to $250,000 of its research credit to reduce the Social Security tax portion of its federal payroll tax bills. Under the old rules, businesses could use the credit to offset only their federal income tax bills. However, many small companies owe little or no federal income tax, especially small start-ups that tend to incur significant research expenses.

For the research credit, a QSB is defined as a business with:

Gross receipts of less than $5 million for the current tax year, and
No gross receipts for any taxable year preceding the five-taxable-year period ending with the current tax year.
The allowable payroll tax reduction credit can’t exceed the employer portion of the Social Security tax liability imposed for any calendar quarter. Any excess credit can be carried forward to the next calendar quarter, subject to the Social Security tax limitation for that quarter.

Research activities that qualify

To be eligible for the research credit, a business must have engaged in “qualified” research activities. To be considered “qualified,” activities must meet the following four-factor test:

The purpose must be to create new (or improve existing) functionality, performance, reliability or quality of a product, process, technique, invention, formula or the computer software that will be sold or used in your trade or business.
There must be an intention to eliminate uncertainty.
There must be a process of experimentation. In other words, there must be a trial-and-error process.
The process of experimentation must fundamentally rely on principles of physical or biological science, engineering or computer science.
Expenses that qualify for the credit include wages for time spent engaging in supporting, supervising or performing qualified research, supplies consumed in the process of experimentation, and 65% of any contracted outside research expenses.

Complex rules

The ability to use the research credit to reduce payroll tax is a welcome change for eligible small businesses, but the rules are complicated, and we’ve only touched on the basics here. We can help you determine whether you qualify and, if you do, assist you with making the election for your business and filing payroll tax returns to take advantage of the new privilege.

How should C corporations tackle year-end tax planning amid uncertainty?

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As the year end approaches, C corps should decide when and how to shift income and deductions between 2017 and 2018. Despite the uncertainty in tax reform proposals (nobody knows when a law might be enacted and what net effect the new rules may have), the best year-end tax planning strategy may be to follow the time-honored approach of deferring income to 2018 and accelerating deductions into this year to minimize 2017 taxes. Contact us for the best path forward in your situation.

A tax reform plan has been released

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The Trump Administration and select members of Congress have released a “unified framework” for tax reform. It provides more detail than other tax reform documents that have emerged from the White House over the past few months, but it still leaves many specifics to be worked out by Congressional tax-writing committees (the House Ways and Means Committee and the Senate Finance Committee). Among the provisions: a top tax bracket of 35% as compared with 39.6% today. More Information on the plan here

Are You Aware of New Tax Rules for Partnerships?

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If your business is a partnership, new audit and adjustment rules passed by Congress have significantly increased the chances that it could be audited. Your partnership operating agreement should be reviewed and possibly revised to address the rules and the new tax terms and concepts that they introduce. It is possible for some partnerships to opt out of the rules’ provisions, but careful consideration should be given to this decision and to other concerns.

While the rules generally apply to returns filed after 2018, we recommend that you begin planning now to prevent any unexpected consequences when they do become effective. We urge you to contact us today for more information on how the new rules might apply to your business and what steps you should take to address them.