Using Your R&D Tax Credit Against Payroll Taxes

As you wrapped up the 2023 books for your startup, you probably did some high-level financial review and analysis. Looking over key documents like your profit and loss statement, you get a better idea of what’s driving revenue — and where you’re spending. 

For most companies, payroll makes up a huge category in the latter. Paying your team is likely one of the biggest, if not the biggest, expenditures for your company. It’s a key component in keeping things running, of course. But you see that total and it can sting a little.

Fortunately, there’s a way to minimize that pain while still paying your employees the salaries and hourly wages they deserve. And as a tech startup, you can most likely capitalize on it in a big way. It’s the R&D credit that the IRS will let you apply toward payroll taxes. 

Reducing your payroll tax liability

The IRS has long offered a tax credit for increasing research activities. Basically, the rule goes that as long as you’re spending money on things like equipment and salaries for R&D, you can claim a tax credit for a portion of those expenditures. Of course, as with all things IRS, it can get complicated. But we have an R&D tax credit overview blog to help you get a good feel for how this potentially significant tax credit works. 

It’s important to note that the changes to Section 174, as part of the Tax Cuts and Jobs Act, can have a direct impact on the R&D Tax credit. With the requirement to capitalize and amortize R&D expenses over several years, the tax benefit from these credits may be reduced or spread out over a longer period, affecting your overall tax savings. More information on that here. 

Historically, many startups could qualify for that R&D credit — but it did them no good. That’s because the credit could only be applied toward their income tax liability. And as a startup, that liability might not exist for the first few years.

Fortunately, post-Protecting Americans From Tax Hikes (PATH) Act, things have changed. Now, you can apply that research tax credit toward your payroll tax liability instead of your income tax liability. So even if you’re not reporting any income to the IRS yet, you can still use this tax credit to keep more money in your startup. 

Specifically, you can use this credit toward up to $250,000 of the employer portion of the payroll social security tax. As a quick reminder, this is the 6.2% of each employee’s earnings that you pay into social security. (You can’t apply the R&D credit toward the 6.2% your employees are responsible for paying that you likely automatically deduct from their paychecks.) 

The Inflation Reduction Act of 2022 has brought some significant amendments to the R&D Tax Credit, making it more accessible and beneficial for qualified small businesses (QSBs). The maximum credit limit that can be applied against payroll taxes has been increased from $250,000 to a whopping $500,000 for tax years starting after December 31, 2022.

Getting this credit applied to your payroll tax

To use this credit to reduce your payroll tax liability, you need to be in the first five years of generating gross receipts. In other words, don’t wait until you have your startup more established to act. 

If you’ve already got too much on your plate — as most founders and executives do — don’t worry. Our team at ShayCPA specializes in helping companies like yours maximize their R&D credit and apply it to reduce their tax liability. 

In fact, we offer fixed-fee R&D credit studies to help you figure out exactly how much you can claim. What’s more, we won’t charge you for the study until after the IRS credit hits your bank and we offer audit support should you ever need it. 

Completing the required paperwork

As you can probably expect, the IRS isn’t going to voluntarily extend this potentially money-saving credit to you (up to $500k!). Instead, you need to complete some steps to both claim this credit and apply it toward the employer portion of your payroll social security tax. 

That starts with completing and submitting Form 6765, Credit for Increasing Research Activities. To claim the credit, you need to get this submitted by attaching it to your business income tax return. In other words, you can’t make this election retroactively. 

But again, don’t worry. We can help you complete Form 6765, prepare your 2023 tax return, and submit them together to make everything as easy as possible. 

With Form 6765 submitted with your tax returns, you still need to complete one more step to tell the IRS you want to apply that credit toward your payroll taxes. Specifically, you need to complete and submit Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. To submit it, you need to attach it to your payroll tax returns (e.g., your quarterly Form 941). 

The bad news? Because you most likely submit your payroll tax returns quarterly, you also need to prepare and submit Form 8974 on a quarterly basis. That’s the only way to ensure that you get the credit applied to that quarter’s payroll social security tax. 

The good news? We have two pieces of good news, actually. First, Form 8974 is just one page and it’s pretty straightforward, at least as far as IRS forms go. Secondly, you don’t need to worry about it at all. Our team can come alongside you to ensure that the form gets completed and submitted on time to help you maximize this tax credit and keep more money in your startup. 

Help along the way

Reading all of this might make you feel equal parts optimistic (paying less in taxes is great) and overwhelmed (more IRS forms with regular due dates are not). We’re here to step in so you don’t leave money on the table. 

Having a team of CPAs at your side goes a long way. When those CPAs understand the tech world, the help goes even further. We know which relatively niche and nuanced startup activities might help you claim a bigger R&D credit, for example. Then, we apply our tax expertise to make sure all of the paperwork is in order to help you claim that credit and stand up to an audit, should that occasion ever arise. 

Ultimately, your startup shouldn’t wait until it’s more established to start exploring the tax credits that could help it save. In fact, some of the biggest — like the R&D credit toward your payroll social security taxes — might not apply if you wait too long.

To get started so you don’t leave money on the table, get in touch.