A practical guide to the enhanced R&D tax credit program for small businesses and startups
The Federal-Level Research and Development Tax Credit Program, or RTCP, was originally enacted in the Internal Revenue Code through the Economic Recovery Tax Act of 1981 as a temporary provision at a time when research and development jobs were significantly declining throughout the United States.
Notably, the RTCP was introduced in the Code to encourage businesses to invest in significant research and development efforts with the high expectation that such an advantageous tax incentive program would help stimulate economic growth and investment throughout the United States and prevent further jobs from being outsourced to other countries.
In December 2015 the Protecting Americans from Tax Hikes Act of 2015, or PATH Act, significantly enhanced the RTCP on myriad levels by making it a permanent tax incentive within the Code and considerably restructured the program to:
• Allow eligible “small businesses” (i.e., $50 million or less in gross receipts) to claim the RTC against the Alternative Minimum Tax for tax years beginning on Jan. 1, 2016; and
• Allow eligible “start-up companies” (i.e., those with less than $5 million in gross receipts and earning revenue for less than five years) to claim up to $250,000 of the RTC against the company’s federal payroll tax for tax years beginning on Jan. 1, 2016.
Eligible Small Businesses Can Now Claim the RTC against AMT
Businesses with average annual gross receipts of less than $ 50 million are now eligible to offset both their regular income tax and their AMT with RTCs. Before the enactment of the PATH Act, businesses in AMT positions were unable to utilize their RTCs to offset their tax liability. Regardless, it is important to point out that RTCs can generally be either carried back 2 years or carried forward up to 20 years before the RTCs could expire unutilized.
Eligible Small Business Best Practice Guidelines
• Pursuant to Section 38(c)(5)(C), an eligible “small business” is defined as a corporation that is not publicly traded; a partnership; or a sole proprietorship with average annual gross receipts for the three taxable year period preceding the current taxable year not exceeding $50 million; and
• Pursuant to Section 448(c)(3), if the business (i.e., including a predecessor entity) was not in existence for an entire three-year period, then the gross receipts test applies to the period it was in existence, and gross receipts for short taxable years shall be annualized.
Eligible Startup Companies Can Now Offset Payroll Taxes with RTCs
Businesses with less than $5 million in gross receipts in the current taxable year (and that have no gross receipts for any taxable year prior to the five taxable year period ending with the current taxable year) can offset the employer portion of Old-Age, Survivors, and Disability Insurance, or OASDI, by up to $250,000 for each year.
Eligible Startup Company Best Practice Guidelines
• If gross receipts are less than $5 million in 2016, then the business must have no gross receipts before 2012;
• Taxpayers must make an annual election specifying the amount of its RTC (i.e., not to exceed $250,000) used as a payroll tax credit, on or before the due date of its originally filed tax return, including extensions. After making the election, businesses may begin to offset the employer portion of OASDI in the following calendar quarter. As a caveat, it should be duly noted that revoking the election requires permission from the Secretary of the Treasury; and
• Social Security tax amounts up to 6.2 percent of an employee’s social security taxable wages for the calendar year (e.g., the 2016 social security taxable wage limit is $118,500).
Three-Step Tax Compliance Reporting Requirements to Offset Payroll Tax with the RTC
1. File Form 6765, “Credit for Increasing Research Activities,” which is currently being revised and finalized so companies can make an annual election to specify the amount of RTCs that will be applied to the employer-portion of Social Security tax. Note, an annual election to apply RTCs can be made for up to five years.
2. File Form 8974, “Qualified Small Business Payroll Tax Credit for Increasing Research Activities,” a new form that businesses will utilize to report the amount of RTCs elected on Form 6765 to offset Social Security tax. The form will be filed with Form 941 each quarter that the credit is applied to the Social Security tax liability. A draft copy of this new form is available for preliminary review at https://www.irs.gov/pub/irs-dft/f8974--dft.pdf .
3. File Form 941, “Employers Federal Quarterly Tax Return,” which is currently being revised and finalized to be able to include the amount reported on Form 8974 each quarter.
When identifying, gathering and documenting a RTC claim, both from a qualitative and quantitative perspective, be sure to adhere to all applicable statutory, administrative and judicial interpretations to ensure both a sustainable tax return filing position per Circular 230 and a sustainable financial statement reporting position per ASC 740 and FIN 48.