In late July, the Senate proposed a bipartisan bill to boost the research credit for new and small businesses. The bill, Research and Development Tax Credit Expansion Act of 2019, would potentially impact taxpayers who are eligible to offset their payroll tax liability with the research credit. The expanded credit would increase the benefit available and allow more businesses to qualify.
Background – Current Law
The research credit was originally enacted as a reduction of income tax liability. For over 30 years the research credit would temporarily expire every 12 to 24 months, until the PATH Act of 2015 permanently extended it. The PATH Act also provided an additional election specifically for start-ups, allowing them to use the credit against payroll tax instead of just income tax. This new law significantly benefited new and small businesses, as in the early years they might not yet be profitable or pay income tax; however, they are still subject to payroll tax.
Qualified small businesses (businesses with less than $5 million in current year gross receipts) can now use the research credit to offset payroll tax for the first five years they generate receipts. (Find out more about the payroll tax offset.) They can use up to $250,000 annually of their research credit (up to five years) to offset payroll tax liability. This election must be made on an original, timely-filed tax return.
Proposed Changes to the Credit
The new bill introduced in the Senate further expands the payroll tax offset opportunity. The bill proposed the following modifications for qualified small businesses:
- Annual credit refund cap increases from $250,000 to $500,000
- Gross receipts limit increases from $5 million to $10 million
- Refundable amounts will cover all payroll taxes paid by such businesses (including unemployment tax and Medicare, instead of only FICA)
Also proposed in the bill was an increase in the alternative simplified credit rate (from 14% to 20%) for taxpayers eligible for making the payroll tax offset election. Filers in their first year of claiming the credit can also apply that rate immediately to their research expenditures to compute the credit.
Small businesses will benefit
If Congress passes the bill, it will generate immediate cash savings for start-up companies. For eligible businesses, the bill would double the amount of research credit that could offset payroll tax, up to $500,000 per year for five years. Also, slightly larger start-up companies would be eligible and could take advantage of the election to offset payroll tax, since the eligibility threshold is doubled from $5 million to $10 million in receipts.
These changes would increase cash and help to fund additional growth for start-ups and other small businesses. It’s a definite win for new companies incurring research expenditures who are looking for ways to continue fueling innovation.
Keep in mind that eligible businesses can already take advantage of this payroll tax offset election, even if the bill is not enacted into law. The new bill just further increases the refund potential and expands eligibility to more businesses.
Please contact us if you have additional questions about how the research credit can help new and small businesses recover cash.