We want to encourage all of our start up friends and their venture investors to take advantage of the new R&D tax credit under the PATH Act.
In short, the tax credit is compelling for small startups because it offsets payroll tax instead of income tax, which pre-revenue companies rarely owe. So it can actually have a $250,000 cash flow impact on small tech companies this year.
Here’s what you need to know – with some help from our tax partners at Sensiba San Filippo.
Under the Protecting Americans from Tax Hikes Act of 2015, a qualified small business (QSB) can elect to use up to $250,000 of its research credits to reduce the Social Security tax portion of its federal payroll tax bills.
A QSB is generally defined as a business with gross receipts < $5 million for the current tax year, and no gross receipts for at least 1 of 5 previous tax years.
Which Research Activities Qualify?
To be eligible for the research credit, a business must have engaged in "qualified" research activities, as defined by these factors.
· It must be R&D to create new or improve existing technology sold in your business.
· There must be an intention to eliminate uncertainty and a process of experimentation.
· The process must rely on principles of physical or biological science, engineering, or computer science.
Expenses that qualify for the credit include wages for supporting, supervising or performing qualified research, supplies consumed in the process of experimentation, and 65% of any contracted outside research expenses.
Timing and Execution
The payroll tax deduction election is made on the federal tax return and then the research is used to reduce federal payroll tax for the first quarter after filing the return. So if you filed your 2016 return in April 2017, it would start in the 3rd quarter of 2017 (now!).
There are separate forms to attach to your federal income tax return and payroll tax return.
Cash is king in an early startup. Many of our clients’ portfolio companies and some of our clients’ operating companies qualify. For more information, contact us – or call your tax advisors.