Summary: Tax legislation at the end of 2015 (The PATH Act) made significant changes to the Research and Development (R&D) tax credit. For tax years beginning in 2016 and forward, credits generated in those tax years by most small start-ups (less than $50 million – three year average gross revenue) are allowed to reduce both the taxpayer’s regular and AMT taxes. This is a significant potential cash savings for many businesses by allowing the credit to be taken against the payroll tax.
Potential R&D Cash Savings for Start-up Companies
Start-up businesses generally produce losses in early years and thus pay little if any income taxes. They do have employees and thus pay payroll taxes. Beginning in 2016, qualified small business start-ups (defined as businesses with less than $5 million in gross receipts and not more than five years of gross receipts) can allocate up to $250,000 of R&D tax credits generated after January 1, 2016 to offset the employer OASDI portion of their payroll taxes.
A company starting business operations in 2016 and claiming the R&D tax credit, can elect to reduce its payroll taxes by up to $250,000 per year for five years so long as annual gross receipts are less than $5 million each year. The R&D credit is calculated on its 2016 tax return and the taxpayer has the opportunity to allocate the credit against 2017 payroll taxes due. The timing of the 2017 payroll tax reduction is related to the date of filing of the taxpayer’s 2016 federal income tax return.
Most of the public discussion late in 2015 and early in 2016 has been about making the R&D tax credit permanent, as well as more widely accessible to all types of businesses. Start-up business owners need to also focus on the significant added actual cash flow benefits that may be available beginning in 2016. The allowed offset of AMT liabilities can be a significant out of pocket cash savings to business owners. For small start-up companies, a payroll tax offset may also result in a significant cash savings.
DS+B partners with several R&D credit specialists. We can assist you in evaluating the cash flow benefits of doing an R&D tax credit study. Given the 2016 R&D credit changes, we envision significantly greater business interest in claiming the credit. Evaluating and arranging a necessary R&D credit study early for 2016 is recommended. For an in-depth discussion on how this may affect your business, please contact us.