R&D tax credit and the payroll tax offset

The Section 41 research credit rewards qualified research expenses: wages of people performing or directly supervising research, supplies consumed in it, and a portion of contract research. A clinical-stage biotech typically has large qualifying wages and contract research, so the credit is meaningful. The catch has always been that a company with no income tax owes nothing for a credit to offset.

Since 2016 a qualified small business, meaning one with under $5 million of gross receipts and no gross receipts more than five years back, can elect to apply the credit against the employer share of payroll taxes. The annual cap is $500,000 for tax years beginning after 2022. That turns the credit into cash within the year, which for a startup can equal a month of runway.

The credit requires a study documenting the qualifying activities and costs, is claimed on the timely filed return, and interacts with Section 174. Many states, including Massachusetts, offer their own credits with different rules.