Gross receipts definition in R&D credit may limit its benefit to startups

Editor: Mark Heroux, J.D.

The research and development (R&D) credit provides an incentive for companies to invest in innovation in the United States. The credit is available to companies in any industry that develop new products or processes or improve upon existing products or processes. Companies that qualify can claim certain wages, supplies, and contract research costs associated with R&D projects and activities.

Since the R&D tax credit is a nonrefundable credit, startup companies are frequently limited in their ability to claim it in the current tax year because they have net operating losses. For example, a startup company that is not yet generating taxable income will not have federal income tax liability needed to use the R&D credit originating in the credit-claiming year. Although the R&D credit may be carried forward for 20 years, the company will receive no immediate tax advantage from the credit in its early years when R&D activities may be substantial.

A payroll tax offset rule included in the Protecting Americans From Tax Hikes (PATH) Act of 2015, P.L. 114-113, helps to remedy this limitation by allowing certain small businesses to offset the R&D credit against payroll taxes instead of federal income taxes for tax years beginning after Dec. 31, 2015. This change in the law to offset payroll taxes may provide a significant cash flow opportunity for small businesses and startup companies that do not have federal income tax liability to otherwise offset the credit.

To qualify for the payroll tax offset under the new law, a business must be a qualified small business, which is defined as having gross receipts of less than $5 million for the tax year and no gross receipts for any tax year before the five-tax-year period ending with the tax year. To illustrate, if the credit-claiming tax year is 2016, a company must have had less than $5 million of gross receipts in 2016 and no gross receipts prior to 2012.

Despite this welcome news for small…

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