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Answers to 3 Common Questions After Filing Your Tax Return

Answers to 3 Common Questions After Filing Your Tax Return
Answers to 3 Common Questions After Filing Your Tax Return 850 500 smolinlupinco

The 2023 federal tax filing deadline has come and gone. (Unless, of course, you filed for an extension until October 15.) Whether you’ve already filed or you’re still working on your return, you might have some questions once it’s been filed.

Let’s take a look at three of the most common ones.

1. When can I expect to receive my tax refund?

If you waited until the final hour to file, you may still be waiting for your return. The IRS says nine out of ten taxpayers should see their refunds within 21 days.

If you’re concerned that it’s taking too long, the IRS has an online tool that can help. Just type irs.gov into your browser and click on “Get your refund status.”

Make sure you’re prepared, though. You’ll need: 

  • Your social security number or individual taxpayer identification number 
  • Filing status 
  • Exact refund amount 

2. How do I need to keep tax records?

Typically, the statute of limitations for the IRS to audit your return or assess additional taxes is three years after you file your return. Thus, it’s a good idea to hold onto tax records related to your return for at least this long.

However, the statute of limitations is actually six years for taxpayers who underreport their gross income by more than 25%.

It’s a good rule of thumb to keep your actual tax returns indefinitely. That way, you can prove that you filed a legitimate return if needed. (No statute of limitations applies for an audit if you didn’t file a return or you filed a fraudulent one.) 

Retirement account records should be kept until three or six years after you’ve depleted the account and reported the last withdrawal on your tax return.

Real estate or other investment records should be kept for as long as you own the asset or until three or six years after you sell it and report the sale on your tax return. 

3. What do I do if I fail to report something? 

In most cases, you can file an amended tax return on Form 1040-X and claim your refund. You’ll need to do this within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later.

For example, if you filed a 2023 tax return on April 15, 2024, you’d be able to file an amended return until April 15, 2027.

There are some circumstances in which you could have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. Typically, you can amend a tax return to claim a bad debt for seven years after the due date of the tax return for the year that the debt became worthless. 

Questions? Smolin can help

Questions about filing an amended return, or accessing your refund? We’re here to help—and not just during tax season! Feel free to contact your Smolin accountant for guidance year-round.

How WIP is Audited

How Work In Progress (WIP) is Audited 
How Work In Progress (WIP) is Audited  850 500 smolinlupinco

During fieldwork, external auditors dedicate many hours to evaluating the way businesses report work-in-progress (WIP) inventory. Why is this so important? And how do auditors decide whether WIP estimates are realistic and reasonable? 

Determining the value of WIP 

Depending on the nature of their operations, companies may report a variety of categories of inventory on their balance sheets. For companies that convert raw materials into finished products for sale, WIP inventory is a crucial category to track.

WIP inventory refers to unfinished products at various stages of completion. Management must use estimates to determine the value of these partially finished products. By and large, the more overhead, labor, and materials invested in WIP, the greater its value. 

Typically, experienced managers use realistic estimates. However, inexperienced or dishonest managers may inflate WIP values. This makes a company appear more financially healthy than it is by overstating the value of the inventory at the end of the period and understating the cost of goods sold during the current accounting period. 

Assessing costs correctly

How companies assign cost to WIP largely depends on the type of products they produce. For example, a company that produces large amounts of the same product will often allocate costs as they complete each phase of the production process. If the production process involves six stamps, the company might allocate one-third of their costs to the product at step two. This is called standard costing.

Assessing the cost of WIP becomes a bit more complicated when a company produces unique products, like made-to-order parts or the construction of an office building. A job costing system must be used to allocate overhead, labor, and material costs and incurred.

Auditing WIP

Financial statement auditors examine the way that companies allocate and quantify their costs. The WIP balance increases under standard costing based on the number of steps completed in the production process. Thus, auditors analyze the methods used to quantify a product’s standard costs and the way the company allocates those costs to each phase of the process.

Under a job costing framework, auditors review the process to allocate overhead, labor, and materials to each job. Specifically, auditors test to make sure that the costs assigned to a particular project or product correspond to that job. 

Revenue recognition

Auditors perform additional audit procedures to ensure a company’s recognition of revenue is in compliance with its accounting policies. Under standard costing, companies usually record inventory—WIP included—at cost. Then, revenue is recognized once the company sells the products.

When it comes to job costing, revenue is recognized based on the percentage of completion or completed-contract method.

Questions? Smolin can help

Whichever method you use, accounting for WIP dramatically impacts your business’s income statement and balance sheet. If you need help reporting WIP properly, reach out to your Smolin accountant. We’re here to help.

Retirement Account Required Minimum Distribution (RDM) Laws Are Evolving

Retirement Account Required Minimum Distribution (RDM) Laws Are Evolving
Retirement Account Required Minimum Distribution (RDM) Laws Are Evolving 850 500 smolinlupinco

Do you have a tax-favored retirement account, such as a traditional IRA? If so, that account will be subject to the federal income tax required minimum distribution (RMD) rules once you reach a certain age. (This applies even if you acquired the tax-favored retirement via an inheritance.)

These rules mean you’ll have to:

A) Make annual withdrawals from the account(s) and pay any resulting income tax
B) Lower the balance of your inherited Roth IRA sooner than you may have planned

But even if this information isn’t news to you, recent tax law changes could impact the way you approach these accounts. Let’s take a deeper look at the most recent rules. 

What to know about Required Minimum Distribution (RMD) 

Under RMD rules, affected individuals need to take annual withdrawals (required minimum distributions) from tax-favored accounts. Unless the RMD meets the definition of a tax-free Roth IRA distribution, doing this will typically trigger a federal income tax bill. A state tax bill is also possible.

There is a favorable exception for original owners of Roth IRA accounts, who are exempt from RMD rules during their lifetimes. However, RMD rules do come into play for inherited IRAs, including Roth IRAs.

Starting age delayed

Enacted in 2022, the SECURE 2.0 law adjusted the age at which account owners must start taking RMDs. Instead of taking RMDs for the calendar year in which you turn age 72, you may now decide to wait to take your initial RMD until April 1 of the year after you turn 72.

SECURE 2.0 also increased the starting age for RMDs to 73 for account owners who turn 72 between 2023 and 2032. So, if you turned 72 in 2023, you’ll be 73 in 2024, and your initial RMD will be for calendar 2024. You must take that initial RMD by April 1, 2025. Otherwise, you could face a penalty for failure to follow the RMD rules.

The tax-smart strategy is to take your initial RMD, which will be for calendar year 2024, before the end of 2024 instead of in 2025 (by the April 1, 2025, absolute deadline). Then, take your second RMD, which will be for calendar year 2025, by Dec. 31, 2025. With this approach, you avoid having to take two RMDs in 2025 and paying double the taxes in that year.

Penalty reduced

The IRS can assess an expensive penalty if you fail to withdraw at least the RMD amount for the year. Prior to the enactment of SECURE 2.0, this penalty was 50% on the shortfall. That penalty is now 25%, or 10% if you withdraw the shortfall within the designated  “correction window.”

10-year liquidation rule draws controversy

Under the original SECURE Act, most non-spouse IRA and retirement plan account beneficiaries are required to empty inherited accounts within ten years of the account owner’s death. Otherwise, they may face a penalty tax for failing to comply with the RMD rules.

According to IRS proposed regulations issued in 2022, beneficiaries who are subject to the original SECURE Act’s 10-year account liquidation rule must take annual RMDs, calculated in the usual fashion — with the resulting income tax. The inherited account must still be empty at the end of the 10-year period. This means beneficiaries can’t just wait ten years and then empty the inherited account.

This requirement to take annual RMDs during the ten-year period has drawn much debate. And, as a result, the IRS stated in Notice 2023-54 that beneficiaries subject to the ten- year rule who did NOT take RMDs in 2023 will not be penalized. The Notice also explains that the IRS will issue new final RMD regulations, which won’t take effect until sometime in 2024 (at the earliest). 

Questions? Smolin can help

Required Minimum Distribution rules can be confusing, especially for beneficiaries. However, breaking these rules can be costly. Contact your accountant for the most up-to-date advice on the best tax-wise RMD strategy for your unique situation. 

2024 Q2 Tax Deadlines for Businesses and Employers

Key 2024 Q2 Tax Deadlines for Businesses and Employers
Key 2024 Q2 Tax Deadlines for Businesses and Employers 850 500 smolinlupinco

The second quarter of 2024 has arrived! If you’re a business owner or other employer, add these tax-related deadlines to your calendar. 

April 15

  • Calendar-year corporations: File a 2023 income tax return (Form 1120) or file for an automatic six-month extension (Form 7004) and pay any tax due.
  • Corporations: Pay the first installment of estimated income taxes for 2024. Complete Form 1120-W (worksheet) and make a copy for your records.
  • Individuals: File a 2023 income tax return (Form 1040 or Form 1040-SR) or file for an automatic six-month extension (Form 4868). Pay any tax due.
  • Individuals: pay the first installment of 2024 estimated taxes (Form 1040-ES), if you don’t pay income tax through withholding.

April 30

  • Employers: Report FICA taxes and income tax withholding for the first quarter of 2024 (Form 941). Pay any tax due.

May 10

  • Employers: Report FICA taxes and income tax withholding for the first quarter of 2024 (Form 941), if they deposited on time, and fully paid all of the associated taxes due.

May 15

  • Employers: Deposit withheld income taxes, Medicare, and Social Security for April if the monthly deposit rule applies.

June 17

  • Corporations: Pay the second installment of 2024 estimated income taxes.

Questions? Smolin can help

This list isn’t all-inclusive, which means there may be additional deadlines that apply to you. Contact your accountant to ensure you’re meeting all applicable tax deadlines and learn more about your filing requirements.

Ensuring Transparency When Using Non-GAAP Metrics to Prepare Financial Statements

Ensuring Transparency When Using non-GAAP Metrics to Prepare Financial Statements
Ensuring Transparency When Using non-GAAP Metrics to Prepare Financial Statements 850 500 smolinlupinco

Mind the GAAP!

Staff from the Securities and Exchange (SEC) commission expressed concerns at last November’s Financial Executives International’s Corporate Financial Reporting Insights Conference about the use of financial metrics that don’t conform to U.S. Generally Accepted Accounting Principles (GAAP).

According to Lindsay McCord, chief accountant of the SEC’s Division of Corporation Finance, many companies struggle to comply with the SEC’s guidelines on non-GAAP reporting. 

Increasing concerns 

The GAAP guidelines provide accountants with a foundation to record and summarize business transactions with honest, accurate, fair, and consistent financial reporting. Generally, private companies don’t have to follow GAAP, though many do. By contrast, public companies are required to follow GAAP by the SEC.

The use of non-GAAP measures has increased over time. When used to supplement GAAP performance measures, these unaudited figures do offer insight. However, they may also be used to artificially inflate a public company’s stock price and mislead investors. In particular, including unaudited performance figures—like earnings before interest, taxes, depreciation and amortization (EBITDA)—positions companies to cast themselves in a more favorable light. 

Non-GAAP metrics may appear in the management, discussion, and analysis section of their financial statements, earnings releases, and investor presentations.

Typically, a company’s EBITDA is greater than its GAAP earnings since EBITDA is commonly adjusted for such items as: 

  • Stock-based compensation
  • Nonrecurring items
  • Intangibles
  • Other company-specific items

Non-GAAP metrics or adjustments can also be selectively presented to give the impression of a stronger financial picture than that of audited financial statements. Companies may also fail to clearly label and describe non-GAAP measures or erroneously present non-GAAP metrics more prominently than GAAP numbers. 

10 questions to ask

To help ensure transparent non-GAAP metric disclosures, the Center for Audit Quality (CAQ) recommends that companies ask these questions: 

1. Would a reasonable investor be misled by the non-GAAP measure presented? What is its purpose? 

2. Is the most comparable GAAP measure more prominent than the non-GAAP measure? 

3. Are the non-GAAP measures presented as necessary and appropriate? Will they help investors understand performance? 

4. Why has management chosen to incorporate a specific non-GAAP measure alongside well-established GAAP measures?

5. Is the company’s disclosure substantially detailed on the purpose and usefulness of non-GAAP measures for investors? 

6. Does the disclosure adequately describe how the non-GAAP measure is calculated and reconcile items between the GAAP and non-GAAP measures?

7. How does management use the measure, and has that use been disclosed?

8. Is the non-GAAP measure clearly labeled as non-GAAP and sufficiently defined? Is there a possibility that it could be confused with a GAAP measure?

9. What are the tax implications of the non-GAAP measure? Does the calculation align with the tax consequences and the nature of the measure?

10. Do the company’s material agreements require compliance with a non-GAAP measure? If so, have those material agreements been disclosed?

The CAQ provides additional questions that address the consistency and comparability of non-GAAP metrics.

Questions? Smolin can help

Non-GAAP metrics do have positive potential. For example, when used appropriately, they can provide greater insight into the information that management considers important in running the business. To avoid misleading investors and lenders, though, care must be taken. 

To discuss your company’s non-GAAP metrics and disclosures in more detail, contact your accountant.

Can Social Security Benefits Be Taxed?

Can Your Social Security Benefits Be Taxed?
Can Your Social Security Benefits Be Taxed? 850 500 smolinlupinco

Did you know that Social Security benefits can be federally taxed? It’s true. Depending on your income, up to 85% of your benefits could be impacted by federal income tax.

Understanding provisional income

How do you determine the amount of Social Security benefits to report as taxable income? That depends on your “provisional income.”

To calculate provisional income, begin with your adjusted gross income (AGI). You can find it on Page 1, Line 11 of Form 1040. Next, subtract your Social Security benefits to arrive at your adjusted AGI for this purpose.

Next, add the following to that adjusted AGI number:

  1. 50% of Social Security benefits
  2. Any tax-free municipal bond interest income
  3. Any tax-free interest on U.S. Savings Bonds used to pay college expenses
  4. Any tax-free adoption assistance payments from your employer
  5. Any deduction for student loan interest
  6. Any tax-free foreign earned income and housing allowances, and certain tax-free income from Puerto Rico or U.S. possessions

Now you know your provisional income. 

Determine your tax scenario

After calculating your provisional income, it’s time to determine which of the following three scenarios you fall under.

  1. All benefits are tax free

If your provisional income is $32,000 or less…

and you file a joint return with your spouse, your Social Security benefits won’t be subject to federal income tax. You may still need to pay state tax. 

If your provisional income is $25,000 or less…

and don’t file jointly, your Social Security benefits are generally federal-income-tax-free. However, if your spouse lived with you at any time during the year and you filed separately, you’ll need to report up to 85% of your benefits as income UNLESS your provisional income is zero or negative.

  1. Up to 50% of your benefits are taxed

If you file jointly with your spouse and have a provisional income between $32,001 and $44,000, you must report up to 50% of your Social Security benefits as income on Form 1040.

If your provisional income is between $25,001 and $34,000, and you don’t file a joint return, you must report up to 50% of your benefits as income.

  1. Up to 85% of your benefits are taxed

If you file jointly with your spouse and your provisional income is above $44,000, you must report up to 85% of your Social Security benefits as income on Form 1040.

If you don’t file a joint return and your provisional income is above $34,000, you will likely need to report up to 85% of your Social Security benefits as income.

Unless your provisional income is zero or a negative number, as mentioned earlier, you’ll also need to report up to 85% of your benefits if you’re married and file separately from a spouse who lived with you at any time during the year.

Questions? Smolin can help

Believe it or not, this is only a very simplified explanation of how Social Security benefits are taxed. Many nuances are involved, and the best way to learn how much, if any, Social Security you’ll need to report as income is to consult with your accountant.

Read This Before Listing Your Property as a Vacation Rental

Read This Before Listing Your Property as a Vacation Rental
Read This Before Listing Your Property as a Vacation Rental 850 500 smolinlupinco

Whether you own a lakefront cottage, vacation beach home, or ski chalet, renting out your property for part of the year can have significant tax impacts.

Here’s what you need to know.

Your level of personal use impacts your taxes

The number of days the property is rented has a direct impact on your taxes.

However, there are certain scenarios that don’t count towards this total since your official “personal use” of the property includes more than your own vacations. It also includes vacation use by your relatives—even if you charge them market-rate rent. It also includes use by nonrelatives if you don’t charge them a market rate rent.

This is important because if you rent the property out for less than 15 days during the year, it’s not treated as “rental property” at all.

Under these circumstances, you could see significant tax benefits since even a significant amount of rental income received won’t be included in your income for tax purposes. However, you also won’t be able to deduct operating costs or depreciation﹘only property taxes and mortgage interest. 

(Mortgage interest is deductible on your principal residence and one other home, subject to certain limits.)

If you do rent the property out for nonpersonal use for more than 14 days, the rent received must be included in your income and you will be able to deduct operating costs and depreciation (subject to several rules). To do this, you’ll need to allocate expenses between rental days and personal use days.

For example, if the house is rented for 90 days and used personally for 30 days, then 75% of the use is rental (90 days out of 120 total days). You would allocate 75% of your maintenance, utilities, insurance, etc. costs to rental. Additionally, you would allocate 75% of your depreciation allowance, interest and taxes for the property to rental. The personal use portion of taxes is separately deductible. If the personal use exceeds the greater of 14 days or 10% of the rental days, the personal use portion of interest on a second home will also be deductible. In this case, though, depreciation on the personal use portion isn’t allowed.

Income and expenses

When rental income is greater than allocable deductions, you’ll need to report both in order to determine how much rental income you should add to your other income for tax purposes. 

When you may claim a loss

If the income is lower than the expenses and you don’t use the property personally for more than 14 days or 10% total percent of rental days, you could be able to claim a rental loss.

When calculating the loss, though, you must allocate your expenses between the rental and personal portions. It’s also important to keep in mind that the loss will be considered “passive” and may be limited under the passive loss rules.

When you cannot claim a loss

If rental income is higher than expenses or if the house is used personally for 10% of rental days or more than 14 days total (whichever is greater), you won’t be able to claim a loss. However, you’ll still be able to use your deductions to balance out rental income. Any unused deductions will be carried forward. This could be usable in future years.

While there are still multiple deductions up to the amount of rental income you can claim, you must use them in this order: 

  • Interest and taxes
  • Operating costs
  • Depreciation

Questions? Ask Smolin

Tax rules for vacation rentals can be complicated. If you plan to rent out your property, it pays to plan ahead. Contact your Smolin accountant to learn how you may be able to maximize deductions in your unique situation.

Estate Planning Don’t Forget the Generation-Skipping Transfer (GST) Tax

Estate Planning? Don’t Forget the Generation-Skipping Transfer (GST) Tax
Estate Planning? Don’t Forget the Generation-Skipping Transfer (GST) Tax 850 500 smolinlupinco

Would you like to include grandchildren, great grandchildren, or nonrelatives who are significantly younger than you in your estate plan? If so, you’ve got more to consider than gift and estate taxes. The generation-skipping transfer (GST) tax may also apply.

GST Tax Basics

One of the harshest taxes in the Internal Revenue Code, the GST tax is a flat 40% tax on asset transfers that “skip persons”. For example, the tax may apply if you plan to leave assets to grandchildren or other family members who are more than one generation below you. (For non-family members, the tax applies when the heir in question is more than 37 ½ years younger than you.)   

Because this tax is calculated in addition to estate and gift taxes, it can significantly impact the amount of wealth you’re able to leave to future generations. 

GST Tax Exemption Under the Tax Cuts and Jobs Act

A generous GST tax exemption may fortunately offer some relief. For persons dying after December 31, 2017 and before January 1, 2026, the Tax Cuts and Jobs act adjusts the GST tax exemption amount to an inflation-adjusted $10 million. That totals $13.61 million for 2024.

Unless congress takes action before this time frame ends, the exemption will shrink back to an inflation-adjusted $5 million starting on January 1, 2026.

Of course, taking advantage of this exemption requires careful planning.

For an exemption to apply in some cases, it’s necessary to allocate the exemption to particular assets on a timely filed gift tax return. This is called an affirmative election.

In some cases, the exemption may be allocated automatically unless you opt out. If you prefer to allocate your exemption elsewhere, this can lead to unwanted results.

Reviewing each transfer for potential GST tax liability is a great way to avoid costly mistakes and ensure your exemption is allocated as advantageously as possible.

What transfers are taxable under the GST?

In addition to direct gifts that skip persons, GST tax applies to two types of trust-related transfers: 

  1. Taxable terminations

Trust assets pass to your grandchildren when your child dies and the trust terminates.

  1. Taxable distributions

Trust income or principal is distributed to a skip person.

Note: Gifts covered by the annual gift tax exclusion aren’t currently subject to the GST tax. 

Protections offered by automatic allocation rules

While the automatic allocation rules can be unfavorable if you prefer to allocate your exemption elsewhere, they’re ultimately intended to protect you against unintentional loss of GST tax exemptions.

For instance, your unused GST tax exemption may be automatically applied to a gift to a grandchild or other “skip person” that exceeds the annual gift tax exclusion ﹘without the need to make an allocation on a gift tax return. 

The rules’ impact on “GST trusts” are complex. A trust is considered a GST trust if it will likely benefit skip persons or your grandchildren in the future.

In most cases, these automatic allocation rules work favorably and ensure your GST tax exemption is applied where it’s most needed. However, they can also lead to unintended and potentially expensive﹘results in other cases.   

Questions? Smolin can help

For many people, the GST tax might not be top of mind right now. After all, the exemption amount is currently high enough that it doesn’t impact most families’ estate plans. 

However, the GST tax exemption rate is expected to decrease significantly after 2025 without action from congress. 

To avoid unexpected costs and to protect your wealth, contact your Smolin advisor.

Stressed About Long-Term Care Expenses Here’s What You Should Consider.

Stressed About Long-Term Care Expenses? Here’s What You Should Consider
Stressed About Long-Term Care Expenses? Here’s What You Should Consider 850 500 smolinlupinco

Most people will need some form of long-term care (LTC) at some point in their lives, whether it’s a nursing home or assisted living facility stay.  But the cost of unanticipated long-term care is steep.

LTC expenses generally aren’t covered by traditional health insurance policies like Social Security or Medicare. A preemptive funding plan can help ensure your LTC doesn’t deplete your savings or assets.

Here are some of your options.

Self-funding

If your nest egg is large enough, paying for LTC expenses out-of-pocket may be possible. This approach avoids the high cost of LTC insurance premiums. In addition, if you’re fortunate enough to avoid the need for LTC, you’ll enjoy a savings windfall that you can use for yourself or your family. 

The risk here is that your LTC expenses will be significantly larger than what you anticipated, and it completely erodes your savings.

Any type of asset or investment can be used to self-fund LTC expenses, including:

  • Savings accounts
  • Pension or other retirement funds
  • Stocks
  • Bonds
  • Mutual funds
  • Annuities

Another option is to tap your home equity by selling your house, taking out a home equity loan or line of credit, or obtaining a reverse mortgage.

Both Roth IRAs and Health Savings Accounts (HSAs) are particularly effective for funding LTC expenses. Roth IRAs aren’t subject to minimum distribution requirements, so you can let the funds grow tax-free until they’re needed. 

HSAs, coupled with a high-deductible health insurance plan, allow you to invest pre-tax dollars that you can later use to pay for qualified unreimbursed medical expenses, including LTC. Unused funds may be carried over from year to year, which makes an HSA a powerful savings vehicle.

LTC insurance

LTC insurance policies—which are expensive—cover LTC services that traditional health insurance policies typically don’t cover. 

It can be a challenge to determine if LTC insurance is the best option for you. The right time for you to buy coverage depends on your health, family medical history, and other factors. 

The younger you are, the lower the premiums, but you’ll be paying for insurance coverage when you’re not likely to need it. Many people purchase these policies in their early to mid-60s. Keep in mind that once you reach your mid-70s, LTC coverage may no longer be available to you, or it may become prohibitively expensive.

Hybrid insurance

Hybrid policies combine LTC coverage with traditional life insurance. Often, these policies take the form of a permanent life insurance policy with an LTC rider that provides tax-free accelerated death benefits in the event of certain diagnoses or medical conditions.

Compared to stand-alone LTC policies, hybrid insurance provides less stringent underwriting requirements and guaranteed premiums that won’t increase over time. The downside, of course, is that the more you use LTC benefits, the fewer death benefits available to your heirs.

Potential tax breaks

If you buy LTC insurance, you may be able to deduct a portion of the premiums on your tax return.

If you have questions regarding LTC funding or the tax implications, please don’t hesitate to contact us.

Questions? Smolin can help. 

If you’re concerned about planning for long-term care, don’t put it off any longer. We’re here to help! Contact your Smolin accountant to learn more about your options for LTC expenses so you can rest easy.

Can the Research Credit Help Your Small Business Save On Payroll Taxes

Can the Research Credit Help Your Small Business Save On Payroll Taxes?
Can the Research Credit Help Your Small Business Save On Payroll Taxes? 850 500 smolinlupinco

Often called the R&D credit, the research and development credit for increasing research activities offers a valuable tax break to many eligible small businesses. Could yours be one of them? 

In addition to the tax credit itself, the R&D credit offers two additional features of note for small businesses: 

  • Small businesses with $50 million or less in gross receipts for the three prior tax years can claim the credit against their alternative minimum tax (AMT) liability 
  • Smaller startup businesses may also claim the credit against their Medicare tax liability and Social Security payroll 

This second feature, in particular, has been enhanced by the Inflation Reduction Act (IRA), which

1. Doubled the amount of payroll tax credit election for qualified businesses
2. Made a change to the eligible types of payroll taxes the credit can be applied to

Payroll election specifics

Limits to claiming the R&D credit do apply. Your business might elect to apply some or all of any research tax credit earned against payroll taxes rather than income tax, which may make increasing or undertaking new research activities more financially favorable.

However, if you’re already engaged in these activities, this election may offer some tax relief.

Even if they have a net positive cash flow or a book profit, many new businesses don’t pay income taxes and won’t for some time. For this reason, there’s no amount against which the research credit can be applied.

Any wage-paying business, however, does have payroll tax liabilities. This makes the payroll tax election an ideal way to make immediate use of the research credits you earn. This can be a big help in the initial phase of your business since every dollar of credit-eligible expenses holds the potential for up to 10 cents in tax credit. 

Which businesses are eligible? 

Taxpayers may only qualify for the payroll election IF:

  • Gross receipts for the election year total less than $5
  • Their business is no more than five years past the start-up period (for which it had no receipts)

To evaluate these factors, an individual taxpayer should only consider gross receipts from the individual’s businesses. Salary, investment income, and other types of earnings aren’t taken into account.

It’s also worth noting that individuals and entities aren’t permitted to make the payroll election for more than six years in a row. 

Limitations

Prior to an IRS provision that became effective in 2023, taxpayers were only allowed to use the credit to offset payroll tax against Social Security. However, the research credit may be now applied against the employer portion of Medicare and Social Security. That said, you won’t be able to use it to lower FICA taxes that are withheld on behalf of employees.

You also won’t be able to make the election for research credit in excess of $500,000. This is a significant uptick compared to the pre-2023 maximum credit of $250,000.

A C corporation or individual may only make the election for research credits that would have to be carried forward in the absence of an election—not to reduce past or current income tax liabilities. 

Questions? Smolin can help. 

We’ve only covered the basics of the payroll tax election here. It’s important to keep in mind that identifying and substantiating expenses eligible for the research credit—and claiming the credit—is a complicated process that involves extensive calculations.

Of course, we’re here to help! Contact your Smolin accountant to learn more about whether you can benefit from the research tax credit and the payroll tax election. 

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