Claiming the R&D Tax Credit for Small Businesses and Startups

The Research and Development Tax Credit, commonly known as the R&D Tax Credit, has been around for decades to incentivize businesses to develop and invest in innovative products, processes, and more. What started out as a complicated tax credit that only large corporations could qualify for has shifted to a more accessible source of cash for any size business. New legislation created even more favorable conditions and expanded the benefit of the R&D tax credit. Read on to see how your small business may be able to take advantage of significant cash savings from R&D – even if you couldn’t before.

The biggest change that allows more businesses to use the R&D tax credit is that the credit can be used as a credit against payroll or alternative minimum taxes (AMT). This is beneficial because startups often operate at a loss and therefore carry no tax liability. Even if a startup or small business was already incurring costs for qualified R&D activities, if it didn’t pay federal or state income tax, the R&D tax credit wouldn’t apply. But thanks to the Protecting Americans From Tax Hikes Act (PATH) of 2015, the addition of the payroll or AMT offset means that startups and other small businesses are now eligible for the credit.

Here’s how it works:

Payroll Taxes

Specifically, qualified businesses can apply the R&D tax credit to the employer portion of Social Security taxes, up to $250,000 annually. Qualified businesses must have annual gross receipts of $5 million or less in the taxable credit year. They must also have eligible R&D credits to use in the taxable year, and the limit to use the payroll offset is five taxable years. To qualify, businesses also should not have had any gross receipts in the five years leading up to the year in which they intend to claim R&D tax credits.

AMT

Previously, the R&D tax credit didn’t apply to Alternative Minimum Tax. To qualify for the AMT offset, qualified businesses must have gross receipts of $50 million or less (on average) for the three previous tax years and be privately held. They must owe AMT in the current taxable year. Privately held means a non-publicly traded corporation, partnership, or sole proprietorship.

These newer benefits apply to tax years beginning after December 31, 2015. Note that the AMT offset for C corporations has been repealed for tax years 2018 and after. For individuals, the AMT exemption amount and exemption phaseout threshold were increased for tax years 2018 through 2025, so this a potentially large benefit for sole proprietors.

Existing benefits of the R&D tax credit that are still in place include the ability to carry forward the credit for 20 years (or carry back for one year), sell or transfer credits to other taxpayers, and refund the credit if the business isn’t currently paying applicable taxes. It can still be applied to cost of supplies, contract research expenses, and rental or lease costs of computers used in qualified activities. Other qualifications to claim the R&D tax credit still apply. Some states also offer similar R&D tax incentives.

Most of the $7.5 billion the federal government distributes annually in R&D tax credits are given to large corporations. With the added benefits of claiming the credit against payroll or AMT, hopefully more startups and small businesses will be able to take advantage of a potentially significant source of cash and a lower tax liability. It might also be worth examining past tax returns to see if these rules would apply to 2016, 2017, or 2018 tax years. To find out if your business qualifies for the R&D tax credit under the new guidelines, contact Naden/Lean today.