Payroll Tax Credit Strategies

Many of our clients claim their R&D tax credit and then go on to apply these credits against future payroll taxes. This is a dollar for dollar offset of a Qualified Small Business’ (QSB) OASDI liability (reported quarterly on Form 941). Note that any amount claimed as a credit against your payroll tax is not allowable as a payroll tax deduction. 

Only QSBs can elect the payroll tax credit. According to the IRS, your business is considered a QSB if it has the following characteristics:

  1. It is not publicly traded
  2. It has less then $5 million in gross receipts for the tax year in which you are claiming the R&D tax credit
  3. It did not have gross receipts for any tax year preceding the five-tax-year period ending with the credit year. (For tax year 2018, your company could not have had gross receipt (revenue) in 2013 or prior.)

QSBs that intend to elect the payroll tax credit should know of a few limitations:

  1. The QSB can only apply up to $250k of their R&D tax credit against future payroll taxes. Any remaining credits can be applied toward income tax or carried forward for 20 years.
  2. The QSB can elect the payroll tax credit for up to five consecutive years, up to $1,250,000.
One of our clients, a pharma company, came up with an interesting strategy regarding their 2018 R&D tax credit. Companies in the pharma industry often take years to reach revenue given the long FDA approval process. This client claimed ~$40k in R&D tax credits for 2018 but opted to carry forward the credit even though they are clearly a QSB and could have used this credits to offset their future payroll taxes. The reason is because this client intends to close its Series B round in the first half 2019 and deploy the capital in hiring additional researchers and scientists. They expect in tax year 2019 they’ll have closer to $150k in R&D tax credits and in 2020, over $200k.
By deferring electing the payroll tax credit for tax year 2018, the client will be able to get closer to the $1,250,000 maximum if they begin electing the payroll tax credit starting in tax year 2019 or 2020. They wanted to start their five consecutive years of electing the payroll tax credit with year 1 being closer to the allowable $250,000 cap. In addition, by closing the fund raising round, they know they will have several years to continue operations and R&D.