Although the R&D credit has been around for over 30 years and the government gives over $10 billion a year to innovative companies, startups are unlikely to have any federal income tax liability in the early years, resulting in low utilization of these tax credits. With the recent changes to the law startups will now finally begin to realize the benefit of these credits as a way to significantly improve cash flow.

What changed? 

Congress made a small but valuable change to the R&D credit in December 2015, allowing a qualifying small business taxpayer to use federal R&D tax credits against their federal payroll tax liability.

Many startups will meet the criteria of a Qualified Small Business (QSB), and can improve cash flow by up to $250,000 a year by claiming federal R&D tax credits under this new provision.

If the company wants to offset payroll tax for the 2016 year, it must make the payroll offset election on its original tax return. Therefore, if the company wishes to use the credit at the earliest point possible and the company has a return due date of 3/15/17, the company should properly quantify the amount of the 2016 credit prior to 3/15/17. This includes documenting the company’s 2016 R&D activities and expenses PRIOR to the 3/15/17 return due date. Once elected on the tax return, the company may then utilize the credit to offset payroll tax on the next quarter’s payroll tax liability up to $250,000 annually.

Who Qualifies?

• A company that is not tax-exempt under Code Sec. 501
• The company can not have had gross receipts prior to the five-tax-year period ending with the credit year(e.g., for credit year 2016, must have no gross receipts in any year prior to 2012).
• Current gross receipts are less than $5 million for the credit year (e.g., less than $5 million in Gross receipts in 2016)