Clarifying the New Payroll Tax Offset

ball-605592_960_720A highlight of 2015 for research and development (R&D) was the passing of The Protecting Americans from Tax Hikes (“PATH”) Act of 2015, which saw the R&D Tax Incentive become permanent. Essentially, taxpayers that couldn’t utilize or take full advantage of the tax credits in the past should now reassess their eligibility and possibly take advantage of this lucrative incentive.

However, there are a lot of questions surrounding the new rules of the permanent R&D Tax Credit, in particular, the new payroll tax offset.

Previously, start-ups that qualified for the federal R&D tax credit but weren’t yet paying taxes had the option to carry forward the credit to use in later years when they do have a tax liability. However, the new R&D tax credit now allows qualified small businesses to elect to use a portion of their R&D tax credit now to offset payroll taxes, instead of waiting to use the credit. This is essentially what the Payroll Tax Offset is.

In summary, the Payroll Tax Offset:

  • Allows a payroll tax offset for start-up businesses (under $5 million in gross receipts).
  • These companies can take a credit against FICA taxes only–other payroll taxes are excluded.
  • Maximum credit is capped at up to $250,000 per year for five years.
  • Effective for 1/1/2016, but not available for 2015 or earlier periods.

To elucidate the above, these companies can now take a credit against the employer’s portion of FICA taxes (6.2%).  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. However, the Payroll Tax Offset only encompasses FICA taxes, other payroll taxes are omitted.

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” is described as a business with under $5 million in annual gross receipts and has no gross receipts exceeding 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 a case study example:

A small company was founded in 2015. It had acquired substantial R&D and payroll expenses, however no revenue was produced. Since it worked at a loss, the small company did not chase any R&D Tax Credit in 2015. Moreover, the small company expects 2016’s activities to be comparable with a payroll tax liability of $100,000 and will be eligible for $150,000 of R&D Tax Credit. Hence, due to the new PATH Act, the small company should secure the $150,000 of R&D Tax Credit in 2016 and select 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.

Bear in mind that the R&D Tax Credit incorporates a diversity of activities (both basic and applied research) and also various industries.  Consequently, it is important that business owners involve the assistance of professionals to decide not only the businesses’ eligibility for R&D Tax Credit but also which R&D activities qualify. Swanson Reed is a specialist R&D tax credit firm who offers expertise across a wide assortment of industries and has helped many clients achieve tax cash savings under the R&D tax credit scheme. Contact us today to find out more.

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