Congress, with the passage of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), enables small businesses to use research and development credits (R&D credits) to offset payroll tax liabilities and Alternative Minimum Tax (AMT) liabilities. Before the enactment of the PATH Act, R&D credits could only offset income tax and thus went largely unused by early-stage companies.
- An “early-stage company” is a company that has had gross receipts for five or fewer years.
- Early-stage companies can now offset up to $250,000 of the employer’s portion of FICA tax annually with R&D credits generated in 2016.
- The company cannot exceed $5 million of gross receipts in the year it elects to apply the R&D credits to its FICA tax liability.
- If a company received the R&D credit for activities in 2016, did not have any gross receipts before 2012, and had less than $5 million of gross receipts in 2016, the company can elect to offset its FICA tax liability by the amount of its R&D credit, up to $250,000.
- If the credit exceeds the company’s FICA tax liability, any excess can be carried forward to offset future FICA tax liabilities until the R&D credit amount is exhausted.
The new credit only offsets the employer’s portion of the Old-Age, Survivors, and Disability Insurance (OASDI) portion of FICA tax. This amounts to 6.2 percent of wages. The employer must still pay the Medicare portion of the FICA taxes. The employer will still be allowed to take a payroll tax deduction for the full amount of the FICA tax. It should be noted that an entity can only make this election for up to five years.
Control group rules must be taken into consideration. Control groups require entities that have common ownership to look at the entities as a whole rather than at each individual entity. Under these control group rules, a controlled group can only elect up to $250,000 in total credit among its various members. Additionally, gross receipts among all of the entities are aggregated and then analyzed. This means that no member of the control group can have gross receipts prior to the five year window and that the aggregate gross receipts among the group cannot exceed $5 million.
A taxpayer may be able to use the R&D credit to offset AMT liability. This provision applies to taxpayers other than publicly traded corporations. To be eligible to use a R&D credit to offset an AMT liability, a taxpayer’s average gross receipts over the last three years must not be in excess of $50 million. Control group rules require some entities to be examined as a whole when determining the average gross receipts. Additionally, a partner or S-Corporation shareholder are eligible for this AMT offset. The partners or shareholders must meet the gross receipts test separately at the individual level.