What is the QSB Payroll Tax Credit?
There are two ways for businesses to utilize the Research and Development Tax Credit:
- Offset income tax liability
- Offset payroll tax liability
The payroll tax credit is most beneficial for new small businesses that are still generating a taxable loss, but still incur payroll costs.
This election benefits eligible startups that have little or no income tax liability according to their lack of taxable profits.
If qualified, a business can elect to apply a portion (or all) of the research credit for the taxable year as a payroll tax credit against the employer portion of the old-age, survivors, and disability insurance tax (“social security tax” equating to about 6.2% of gross wages paid per quarter).
QSB Payroll Tax Credit History
In 2015, the Protecting Americans from Tax Hikes (PATH) Act enacted IRC 41(h) and 3111(f), which allow a qualified small business (“QSB”) to elect to apply a portion of the research credit for the taxable year as a payroll tax credit against the employer portion of the social security tax under the Federal Insurance Contributions Act.
For taxable years beginning after December 31, 2015, and before January 1, 2023, the maximum research credit that could be elected in a tax year to be applied toward payroll taxes was $250,000.
In 2022, the Inflation Reduction Act of 2022 (IRA) increased the annual payroll election amount to $500,000 for tax years beginning after December 31, 2022, for qualified research activities. In addition to the increased limit, the IRA also made changes to the taxes the credit can offset. Now, the payroll tax credit is first used to offset the employer’s share of social security tax up to the original $250,000 per quarter. Any remaining credit then reduces the employer’s share of Medicare tax for the quarter, up to an additional $250,000. If any credit still remains after offsetting both the employer’s share of Social Security and Medicare taxes, the remainder is carried forward to the next quarter. In total, an employer is able to offset up to $250,000 of their Social Security tax and $250,000 of their Medicare tax per eligible year.
How to Qualify?
To qualify as a small business:
- The entity’s gross receipts for the tax year must be less than $5 million
- The entity can not have incurred gross receipts in any tax years preceding the five-tax-year period, including the current tax year being claimed.
How to File for QSB Payroll Tax Credit?
You must make the election and calculate the credit amount on Form 6765 (Credit for Increasing Research Activities).
Then, take the amount from line 44 of Form 6765 and report it on Form 8974 (QSB Payroll Tax Credit for Increasing Research Activities).
The taxpaying entity’s Federal income tax return includes form 6765.
Form 8974 must be subsequently provided to the company’s payroll provider to enact the future payroll tax savings.
You must make the payroll tax credit election by the due date of your originally filed income tax return, including any extensions.
The payroll tax credit becomes available in the first calendar quarter after the qualified small business files its income tax return.
You calculate the R&D tax credit on Form 6765. It typically applies against your income tax liability.
Reach out to us if you qualify as a SM and would like to unlock the R&D tax credit for payroll purposes!
