Small Business Offset for Payroll Tax and AMT
When can you recall new tax laws being good news for business? U.S. manufacturers and technology companies are only beginning to realize that federal income tax provisions contained in the recently enacted Protecting Americans from Tax Hikes Act of 2015 (PATH Act) are certainly worth being excited about.
The PATH Act, which was signed into law in December 2015, made the R&D tax credit a permanent piece of the federal tax code and created additional benefits for small businesses and startup companies.
First, let’s touch on the benefits that exist prior to the new changes:
- The Federal R&D Tax Credit is a general business tax credit for companies that incur R&D expenses in the United States.
- In addition to the Federal R&D credit, 38 states offer their own tax credits, including New Hampshire, Vermont and Massachusetts.
- Federal and state tax credits can amount to as much as 20% of the costs incurred developing new products and/or processes, or improving existing products and processes.
- Almost any industry qualifies, including manufacturing, technology, software development, engineering firms, life science/pharma, construction and many more.
- Companies can claim credits for up to 3 prior years.
- Excess federal R&D credits can be carried forward for up to 20 years. In most states, excess state credits can also be carried forward.
- Most company executives are surprised as to how much of their expenses qualify. Credits can add up to tens of thousands of dollars for companies having less than $5 million in revenue.
New Changes – The Offset of Alternative Minimum Tax
For S-Corps and LLC’s that earn research tax credits as a result of their development efforts, the credits “flow-thru” to the shareholders on their respective Schedule K1s that define their portion of the business earnings. The amount of the credit designated to each shareholder is proportioned according to their percentage share of ownership of the business. This credit is unlimited and directly reduces the taxpayer’s tax liabilities.
Up until now, R&D Tax Credits could only be utilized to reduce “regular tax”, and only then down to the amount of the taxpayer’s AMT. This greatly limited those that could take full advantage of the credit and as a result, taxpayers often had to carry forward the federal credits as long as 20 years.
Eligible small businesses can now use the credit to reduce alternative minimum tax (AMT) as well as regular tax. This change in the tax law will have a profound effect on S-Corps and LLC’s regarding returns filed for 2016 and subsequent years, as the income tax benefits for these entities were severely limited by AMT in prior years.
Eligible small businesses are defined as:
- Corporations, partnerships, and sole proprietorships that had average gross receipts of $50 million or less during the 3 years preceding the tax year in which a claim is to made.
- The corporation’s stock is not publically traded.
- This change is limited to those filings beginning with the tax year 2016 and later.
- For those that have carryforwards from previous years, the credits cannot be used to offset liabilities in the tax year 2016 if the taxpayer is still in AMT. These credits can only be utilized against income tax liabilities only if/when the taxpayer is outside AMT in subsequent years.
New Changes – The Offset of Payroll Taxes up to $250,000 per year
Qualified small businesses are able to offset a portion of their payroll taxes using R&D credits. Such businesses interested in saving valuable payroll tax dollars should understand these key points:
- Beginning in 2017, qualifying businesses may offset the Employer portion (6.2%) of the FICA portion of their payroll taxes using R&D tax credits claimed on their 2016 and future federal returns.
- Qualified small businesses are defined as corporations or partnerships having gross receipts of $5 million or less during the taxable year, and that did not have gross receipts for any year preceding the 5 year period ending with the taxable year.
- R&D tax credits are applied against quarterly payroll tax payments. In any given year, the maximum payroll tax offset allowed is $250,000.
- Payroll tax savings can be realized in 2017, after the corporation’s 2016 federal return has been filed.
- The first quarter eligible for using the R&D Tax Credits against quarterly payroll tax payments is the second quarter, 2017.
- Unused credits can be carried forward and used against future payroll tax payments.
- IRS has updated form 6765 to accommodate this new application of the credit.
- IRS has released a new Form 8974 to be filed with the quarterly Form 941.
To demonstrate how the new regulations would apply to a typical startup company, have a glimpse at the following example:
A manufacturing company founded in 2014 was established by two college friends for the purpose of developing, producing and selling a line of state-of-the-art components for the consumer sound-system market. The owners of the business invested their personal savings into the enterprise and by late 2015 had sold their first 1000 products for a sum of $500,000.
Entering 2016, the company had seven employees on staff, including the owners, all of whom received a W2 salary. Throughout 2016, the company continued its product development and manufacturing efforts, which resulted in revenue of $1,500,000 while incurring $480,000 of qualifying research expenses. In early 2017, the company filed its 2016 tax year return, showing a net loss of $150,000 and an R&D credit of $48,000. Using the R&D tax credit, the company was able to offset $11,500 of the FICA portion of its second quarterly payroll tax payment in 2017. The excess R&D tax credit of $36,500 was then carried forward to offset the payroll tax payment for subsequent quarters.
Dave is a Principal at Business Resource Services (www.BRSHUB.com) where he manages the R&D Tax Credit practice. For further information about how the R&D Tax Credit can help you and your clients please call him at 781-640-6610 or send an email to Dave@BRSVT.com.