The Enhanced R&D Tax Credit and Payroll Taxes
The life science industry is constantly striving to be on the cutting edge of innovation, whether it is the discovery of new treatments, methods of delivery, or improved treatment and monitoring techniques. With ever-growing developments in the industry, entrepreneurs, as well as individuals who have played in this space for years, are starting their own companies with an idea and passion. For these entrepreneurs and individuals, Congress provided a welcomed gift at the end of 2015.
On December 18, 2015, the PATH Act was signed into action, which significantly changed the tax landscape. Of the many provisions that were modified and extended, one crucial area of change was the federal Research and Development (“R&D”) tax credit. Not only was the credit extended permanently, it was considerably enhanced for all taxpayers.
The enhanced ability for Qualified Small Businesses1 (“QSBs”) to utilize the re-designed R&D credit should result in a more immediate benefit. For tax years beginning on or after January 1, 2016, QSBs will be able to elect to apply the R&D credit towards their payroll tax liability rather than their income tax. As a result, they will not have to wait until a profit is generated to take advantage of the R&D credit, which can produce substantial cash savings in the early-stages where tax losses are prevalent, and the credit typically goes unused.
For an eligible taxpayer, an election to apply the R&D credit towards it payroll tax liability2 must be made with the filing of its income tax return. Once made, the credit is available for use against the payroll tax liability beginning after the date on which the QSB files its income tax return. The annual limitation for an eligible year is the lesser of the R&D credit generated or $250,000. The credit cannot exceed the payroll tax that is imposed for any calendar quarter, and any excess must be carried forward to the next calendar quarter filing.
As the life science industry continues to expand, funding the necessary expenditures for ongoing operations can be challenging, and even delay innovation in the early stages. This enhancement of the R&D credit creates a significant cash saving opportunity for small businesses, which allows them to continue investing in innovation.
1 A qualified small business is defined with respect to any taxable year, as a corporation (including an S corporation) or partnership (1) with gross receipts of less than $5 million for the current taxable year, and (2) that did not have gross receipts for any taxable year that occurs before the five taxable year period ending with the current taxable year.
2 The credit is only available to offset the employer OASDI tax liability, it does not apply against its employer health insurance liability or against the employee portion of FICA taxes the employer is required to withhold and remit to the government.