New Payroll Offset Provisions can Help Startups Save an Extra $250,000 Per Year
On Dec. 18, 2015 the President signed the Protecting Americans from Tax Hikes (PATH) Act of 2015. Not only did this bill make the R&D Tax credit permanent, it added the ability to utilize the credit against both Alternative Minimum Tax and payroll tax.
These new provisions create huge opportunities for businesses of all sizes and sectors. But, the companies that clearly stand to benefit the most from these new rules are high-tech startups. To truly understand how the game has changed for these businesses, it’s important to understand how little the R&D credit helped them prior to 2016:
The Dark Ages (1981-2016)
Since its inception, tech startups have always been able to claim the R&D credit. This only made sense, since these small innovative startups have been the primary engine of new economic growth in this country over the last three decades.
However, there was little incentive for startups to claim the credit since it was only useful for offsetting income tax. (Most early-stage startups are not yet profitable, therefore they are not paying income tax.)
However, even if unprofitable, the benefits of the credit were not entirely lost, as the federal research credit did come with a 20 year carry-forward provision (startups that were not profitable could calculate their yearly credit, and then claim those previous credits in up to 20 future years when they became revenue-positive).
Sounded fine in theory; however, in practice the R&D Tax Credit is very complex— in fact, it’s one of the most uncertain areas of the entire tax code. As such, many tax practitioners don’t have the expertise to calculate it, and many of the specialty firms who handle the work charge fees that make the credit cost-prohibitive for cash-strapped startups.
As a result, the businesses that desperately needed cash to continue doing some of the most exciting R&D in the world simply could not justify claiming a credit that wouldn’t benefit them for 10, 15 or even 20 years to come.
The Future – 2016 & Beyond
With the passage of the PATH Act, startup businesses, (Less than $5M in gross receipts) still have ability to carry their R&D credit forward up to 20 years. However they also get an immediate benefit—the ability to offset up to $250,000 worth of current payroll tax.
Since all businesses with employees pay taxes on their payroll, regardless of whether they are profitable, these new rules offer cash savings to startups.
Innovative startups may not be profitable, but if they are paying staff to perform their R&D work, they are able to utilize this credit in the current year against their payroll tax liability, up to $250,000.
No more waiting two-decades for profitability before the credit becomes useful. Small tech startups fighting to grow aggressively now have an immediate incentive to take advantage of the R&D tax credit. That’s good news for them, and for our economy, since every dollar that remains in the hands of these growing startups helps drive further innovation and job creation.