The R&D credit reduces income tax. That is no help to a company that has little or no income tax to reduce, which describes most startups. A provision for qualified small businesses fixes this by letting the company apply part of the credit against its payroll taxes instead.

Who can use it

The payroll offset is meant for young, small companies. According to the IRS instructions for Form 6765, a qualified small business is a corporation (including an S corporation) or a partnership that has:

• Gross receipts of less than $5 million for the tax year

• No gross receipts before the five-tax-year period that ends with the current tax year, which means it is relatively new

The company also needs qualifying research expenses for the year. Your CPA should confirm that the business meets both tests for the year in question.

How much can be used

For tax years beginning after 2022, the election amount is up to $500,000 per year. Before that the limit was $250,000. The credit amount a company elects is the lesser of the credit it has earned and that limit.

How the election works

• The election is made on Form 6765, filed with the income tax return

• It must be made on an original return that is filed on time, including extensions

• The amount is reported on Form 8974, which is attached to the quarterly payroll return

• It can first be used in the first quarter that begins after the income tax return is filed

Because the election has to be made on an original, timely return, a company that missed it cannot usually go back and add it later. That makes the planning conversation with your CPA before filing important.

How the offset is applied

The credit first reduces the employer share of Social Security tax, up to $250,000 per quarter. Anything left over reduces the employer share of Medicare tax for that quarter. If a balance remains after both, it carries forward to the next quarter.

Why it matters for startups

A startup may spend heavily on engineers and still show a loss. Without the offset, the credit sits unused. With it, a company that is paying wages can turn qualifying research spending into a reduction in the payroll taxes it owes.

What counts as research spending

• Wages for people doing, supervising or supporting the qualifying work

• Supplies used in testing and development

• A share of what you pay outside contractors for qualifying work

• Some cloud computing costs used in development

The work still has to pass the four-part test. Routine maintenance, market research and cosmetic changes do not count.

What to do before you elect

• Check that the company meets the gross receipts and five-year tests for the year

• Confirm who prepares the income tax return and who files the payroll forms, so the election and the quarterly claim line up

• Document the qualifying projects and the people on them

• Keep records that tie each cost to a project

A free 5 to 10 minute screening can tell you whether the work looks strong enough to justify the effort, and your CPA can confirm eligibility. For more on what counts, see what qualifies for the R&D credit.