Using the R&D Tax Credit to Offset Payroll Taxes

For companies investing in research and development, the federal R&D tax credit offers a valuable way to reduce tax liability and recoup innovation-related expenses. But for early-stage businesses or those not yet profitable, a common question arises: How can we benefit from a credit against income tax if we don’t owe income tax yet?

The answer lies in the R&D payroll tax offset—a powerful tool that allows qualifying businesses to apply their federal R&D credit against their payroll tax liabilities.

Understanding the R&D Payroll Tax Offset

The R&D tax credit is designed to reward companies for qualifying research expenses—including wages, supplies, and contract research costs. Traditionally, this credit has been applied against income tax. However, qualified small businesses may elect to offset payroll taxes with the credit instead.

To be considered a qualified small business, businesses must:

• Have less than $5 million in gross receipts for the current tax year, and
• Have no more than five years of gross receipts.

To claim the credit, businesses must complete and file Form 6765, Credit for Increasing Research Activities, with their timely filed federal income tax return (including extensions). This IRS form is used to calculate the amount of credit earned, identify qualifying research expenses, and make the election to apply the credit against payroll taxes.  Companies must also attach Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, with their payroll tax return.

For tax years after 2022, eligible businesses can elect to apply up to $500,000 per year of their R&D credit toward payroll taxes—providing cash flow benefits even if the business isn’t yet profitable.

Why This Matters for Your Business

The payroll tax offset can be a game-changer—particularly for startups and growth-stage companies that have no income tax liability. By allowing eligible businesses to apply the R&D tax credit toward their payroll taxes, this provision offers financial relief, often improving cash flow by reducing tax obligations and freeing up capital that can be reinvested into innovation, hiring, and expansion efforts.

Don’t Overlook State Opportunities

To maximize potential savings, take time to explore what’s available in the states where your business operates. A thoughtful, state-by-state review could reveal meaningful incentives to fuel your next phase of innovation.

Important Considerations for the Payroll Tax Offset

While the payroll tax offset can offer significant cash flow advantages—especially for startups and emerging businesses—successfully claiming it requires careful attention to timing, limits, and compliance. To fully benefit from this opportunity, keep the following in mind:

• Election Timing: The election to apply the credit against payroll taxes must be made on a timely filed federal income tax return, including extensions. Missing this window can mean losing the opportunity for the current year.
• Annual Limits: For tax years after 2022, businesses may apply up to $500,000 of the R&D credit annually against payroll tax liabilities.
• Documentation Requirements: The IRS requires clear, up-to-date records of your qualifying research activities and related expenses. Maintaining detailed documentation is crucial for supporting your claim and protecting it in the event of an audit.

Ready to Maximize Your Credit?

If your business is investing in innovation, make sure you capture every opportunity to reduce costs. With the payroll tax offset, your business can turn R&D spending into tangible cash flow relief. Need help determining eligibility, calculating your qualified expenses, or filing the necessary forms? Contact your CRI advisor. We’re prepared to explore how the R&D credit—and the payroll tax offset—can strengthen your bottom line and fuel future growth.