Corporate giants are no longer the only organizations taking advantage of lucrative tax saving opportunities. Startups and small businesses have joined the now-leveled playing field made by federal legislation that has expanded the eligibility criteria for the Research and Development (R&D) tax credit.
R&D tax credit criteria
The R&D tax credit rewards companies for conducting research and development in the United States. The R&D umbrella is broad and can encompass several different types of activities. To qualify as an R&D activity, one must meet each of the following criteria:
- Technological in nature. Activities must be based on hard science.
- Qualified purpose. Activities must be intended to develop a new or improved product or process.
- Technological uncertainty. Activities must be aimed at eliminating uncertainty with respect to the development of a product or process.
- Process of experimentation. Activities must involve a systemic or iterative approach of evaluating different alternatives to eliminate ambiguity.
Small businesses and startup benefit
The most beneficial guidance that affects eligible small businesses and startups is the option to elect up to $250,000 per year of their qualifying research expenses to offset the FICA employer portion of payroll tax. To qualify for this, a business must have current year annual gross receipts of less than $5 million and must not have any gross receipts five years prior to the current year claim. The payroll tax election must also be made on a prompt income tax return, including extensions.
Before this guidance was enacted, small businesses who had eligible research expenses but possessed little to no income tax liability were not able to capitalize on the R&D credit. Now, taxpayers can capture potential payroll tax savings of up to $1,250,000 over five years.
Newer legislation also allows some taxpayers and eligible small businesses—defined as corporations that aren’t publicly traded, a partnership, or a sole proprietorship with average annual gross receipts not exceeding $50 million for three taxable years before the current taxable year—too small to absorb the entire R&D tax credit to get the credit against their alternative minimum tax (AMT) liability. Since the tax reform law passed in 2017, AMT has been repealed for C corps beginning in 2018 but remains in place for individuals, including those who possess ownership in S corps or partnership.
About the author
Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors.