2017 Year-end tax letter | How small businesses can use the research credit to offset the payroll tax

Authored by Wendy Landrum

Businesses that increase certain qualified research expenses may benefit from a research credit to reduce their income tax liability. For tax years that begin after Dec. 31, 2015, eligible small businesses can take advantage of a new rule enabling them to apply part or all of their research credit against their payroll tax liability, instead of their income tax liability. The option to elect the new payroll tax credit may be especially helpful for eligible startup companies that have little or no income tax exposure.

Under the new rules, an eligible small business with qualifying research expenses can choose to apply up to $250,000 of its research credit against its payroll tax liability. To qualify for the new option for 2017, a business must have gross receipts of less than $5 million and may not have had gross receipts for the five preceding tax years before 2017. For example, if the credit-claiming taxable year is 2016, a business must have had less than $5 million of gross receipts in 2016 and no gross receipts prior to 2013.

The IRS recently issued interim guidance clarifying that gross receipts, for purposes of the payroll tax offset, include: total sales (net of returns and allowances), all amounts received for services and any income from investments and other incidental sources. Therefore, investment income from interest, dividends, rents, royalties and annuities are included as gross receipts for purposes of determining eligibility. As a result, certain small businesses and startup companies may not be eligible for the payroll tax offset and may not be able to monetize their investments in R&D activities. The IRS requested comments on the interim guidance.

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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.