The PATH Act allows small businesses, that typically do a lot of research and development while getting their businesses up and running, to receive credits against their payroll tax right away.

R&D tax credit overview

If you are a financial professional or handle finances for a small business, you may be familiar with the federal Research and Development Tax Credit ("R&D Credit"). The Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently extended the R&D Credit and expanded it to make it easier for eligible startups and small businesses to monetize the credit.

R&D is not just for major corporations with research labs. Businesses of all sizes and types can benefit from this credit based on qualifying activities. The R&D Credit has significant benefits for small businesses that help improve cash flow and positively impact financial statements, including:

  • A dollar-for-dollar tax benefit of up to 20% of the eligible R&D spending above a base amount calculated from prior years and carrying forward unused R&D Credits for up to 20 years
  • Ability to offset AMT for qualified small businesses (50M or less in average gross receipts for prior 3 years)
  • Up to a $250,000/ year tax credit against federal payroll tax liability for qualified startups

Prior to 2016, the R&D Credit had expired and been extended 15 times since 1981. A primary objective of the credit is to incentivize technological development within the United States. The PATH Act allows small businesses, that typically do a lot of research and development while getting their businesses up and running, to receive credits against their payroll tax right away. In turn, they can reinvest those savings into their businesses.

How does a business claim the R&D Tax Credit?

Capturing the R&D Credit isn't easy. Fewer than one-third of the companies that qualify for the credit actually claim and secure them. Businesses must identify, document and support their qualifying R&D activities and expenses in a comprehensive R&D study. And if you have ever been involved in preparing one, you understand the workload.

In addition to the federal R&D Credit, many states offer R&D tax credits as well, and these continue to change. For example, Virginia Bill H.B. 748 extended the sunset date from January 1, 2022, to January 1, 2027 for the State R&D credit and increased the aggregate cap for both the research and development expenses tax credit and the major research and development expenses tax credit. When assessing R&D tax credit opportunities, you will want to look into state incentives as well.

Why partner with a tax credit expert?

Working with a firm that has focused expertise in tax credits can be a smart choice for businesses of any size and for CPAs who prepare taxes for business clients. Sanjiv Gaitonde, Senior Tax Manager, R&D Tax Credits at ADP knows well the complexity involved in claiming R&D Credits, as well as how partnering with experts can make it easier: "Such a partner can analyze financial, payroll, and technical data and documentation, help identify qualified R&D activities and expenses, help ensure accuracy and prevent penalties and interest due to improper classifications."

Tax credit experts also stay up-to-date on constantly changing extensions and legislative and judicial updates in federal and state tax credits, which helps minimize risk and maximize credits.

Payroll wages are a critical component of an R&D study, and if you are already using a payroll company that offers tax credit services, they can easily and securely pull information from your W-2s to help find qualified research expenses.

"ADP additionally has an experienced team of CPAs, attorneys, engineers, and scientists that can help identify and document qualified activities, help identify the associated qualified expenses, and help define a clear nexus between the qualified activities and expenses. This is what the IRS or state taxing authorities typically look for in the event of exam," says Gaitonde.

Optimal tax credit support for small businesses

While small businesses are audited less frequently than larger ones, if your small business or client is audited by the IRS and the credits are denied, using a firm to calculate the client's tax credit can prevent the IRS from levying penalties on your client and preparer penalties against you. ADP's tax credit services, for example, include full IRS and state taxing authority audit support.

Partnering with an expert is a great way to offer your clients an additional service without adding to your own time and labor, and provide optimal tax credit support with little risk to you.

Learn more in our Tax Credit Strategy Guide. This guide shares how tax credits work, how to optimize your business tax credits and essential components of a successful tax credit strategy.

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