The R&D tax credit has been available to small businesses as a payroll tax credit since 2016. And yet every year, some of the taxpayers that are eligible for this credit fail to claim it.
Now that the Inflation Reduction Act has doubled the maximum R&D credit from $250,000 to $500,000, it’s prime time to make sure none of your qualified small business clients are missing out on a tax break. CPAs may provide a highly valuable service to startups and other tech- or research-based clients by walking them through the process of claiming any R&D credit they’re entitled to take.
Catching Up on the R&D Tax Credit
If you need it, here’s a basic overview of how the R&D tax credit works, and how the Inflation Reduction Act and Tax Cuts and Jobs Act have affected R&D tax issues recently.
In short, the R&D tax credit is designed to offset costs related to research and development. It’s a payroll tax credit that a qualified employer can claim against its portion of Social Security taxes. The tax credit takes the form of a refund.
Qualified small businesses meet three criteria to claim the R&D credit:
- They have gross receipts of less than $5 million for the current tax year.
- They have no more than five years of gross receipts preceding the current tax year.
- They’re doing qualified R&D work. The IRS determines “qualified research” using the four-part test in section 41(d) of the IRC.
Qualified taxpayers are allowed to claim a maximum deduction of $250,000 against their Social Security/FICA taxes. That maximum was doubled by the IRA, effective tax year 2023. However, the additional $250,000 may only be claimed against a business’s Medicare taxes. With Medicare’s significantly lower employer tax rate (1.45% vs. 6.2% for FICA), clients who qualify for the $250,000 maximum credit will get a lower rate of return on their second $250,000 in qualified research expenses.
The TCJA did not create significant changes to the R&D tax credit. But clients that qualify for the credit are also affected by the provision that took effect in tax year 2022, requiring taxpayers to amortize R&D expenses over five or 15 years rather than deduct them immediately.
The R&D Credit and Payroll
One great thing about the R&D credit is that employee wages can count toward a qualified small business’s credit amount. Section 41 defines qualified wages as those paid to employees who are “engaging in,” “directly supervising” or “directly supporting” qualified research. Any business that’s working in R&D in any capacity is generally going to have in-house employees whose wages qualify toward the business’s tax credit.
From a payroll perspective, the challenge becomes identifying what portion of wages a client spent on employees doing qualified research vs. doing other activities. For a CPA who’s analyzing a client’s records in anticipation of claiming the tax credit, the complexity of calculating qualified wages comes down to a few things. Namely, the size of the workforce and scope of its research activities, and the accuracy and accessibility of the client’s payroll records. It’s going to be a lot faster and easier to calculate accurate numbers for Form 6765 when a client’s payroll records are both comprehensive and searchable.
Why aren’t your clients applying for the R&D tax credit?
The kinds of companies that qualify for the R&D tax credit are often companies that need extra support from their CPAs at tax time. Leaders at startups and small businesses in the tech, engineering and research worlds tend to have a lot of plates spinning. Payroll tax credits are probably not something many of these clients have time to think about or, ironically, time to research.
Reasons qualified small businesses might not apply for the R&D tax credit include:
- They don’t know it exists.
- They know it exists, but don’t think it applies to them.
- They’re intimidated by the process of claiming the credit, or too busy to deal with it.
In other words: All problems a great CPA can solve.
CPAs who are proactive about R&D tax credit opportunities could potentially help qualified clients save thousands of dollars they didn’t even know they were entitled to. From alerting them to the existence of the tax credit, to spearheading the analysis that determines how much of a credit they’ve earned, to completing and filing Form 6765, getting an R&D tax credit is a key way for a CPA to generate value for qualified clients (and get paid for doing it!). Who wouldn’t be thrilled to learn that their CPA has identified a tax credit that could save them up to half a million dollars, and that they don’t have to do the heavy lifting to actually get the money?
Have Questions About Payroll and the R&D Tax Credit?
Busy CPAs don’t have time to sift through (virtual) mountains of payroll data when they’re helping clients calculate their R&D tax credits. It can be easy to find and interpret all the relevant data in the client’s payroll system, in order to determine how much has been spent on qualified wages with the right support.
CPAs in ConnectPay’s CPA Partners program have a Connected Services Representative and a CPA Client dashboard to reference. Connect with us now to learn more about how ConnectPay can make payroll easier for CPAs and their clients.
By Drew Schildwachter
Drew Schildwachter has worn many hats over the years as a contractor, video retail multi-unit franchisee partner and operations director, turnaround specialist, and, most currently, operations leader at ConnectPay Payroll Services. One of his specialties is understanding the challenges of the small business owner and how various best practices in the payroll process and business administration can alleviate pain points for them. He has presented eight webinars to date about PPP, including for the Massachusetts Society of CPA’s CPE credit series.