The Credit for Increasing Research Activities under Internal Revenue Code Section 41 is a Federal tax credit that, in most cases, reduces the income tax liability of the business claiming the credit. However, many life science companies incur significant research expenses while in their pre-revenue stage. Accordingly, they don’t have a tax liability to offset, and the credit is of limited use.
To help stimulate research activities for this segment of taxpayers, Section 41 allows the credit to be applied against an employer’s portion of Social Security and Medicare payroll taxes. This election to offset payroll taxes was created under the 2015 Protecting Americans from Tax Hikes legislation (PATH) and was further expanded in the 2022 Inflation Reduction Act (IRA). To be eligible to make the election, the business claiming the credit must be a Qualified Small Business (QSB). A QSB is a company that has gross receipts of less than $5,000,000 for the applicable tax year and has less than 5 years of revenue history.
A company can make the payroll tax credit election annually through Form 6765, Credit for Increasing Research Activities, which is then attached to the company’s income tax return. For tax years beginning after 2022, the maximum payroll credit allowed is $500,000, which is a two-fold increase from the prior limit of $250,000. The credit must be claimed on Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, and attached to Form 941, Employers Quarterly Payroll Tax Return. On Form 941, a company will report the payroll credit amount up to, but not exceeding, the employer’s share of Social Security and Medicare taxes for that quarter. Any portion remaining after application against the employer’s Social Security and Medicare tax is carried forward to future quarters. This credit cannot be carried back to prior quarters or years.
WG observation: While applying the QSB rules, be mindful that there is no de minimis amount of gross receipts. This means that, regardless of the amount, taxpayers must consider even a nominal amount of revenue when applying the 5-year revenue lookback period to determine QSB eligibility.
If you have questions or need further information, please contact your WG advisor.
