News & Tech Tips

The election to apply the research tax credit against payroll taxes

The credit for increasing research activities, often referred to as the research and development (R&D) credit, is a valuable tax break available to eligible businesses. Claiming the credit involves complex calculations, which we can take care of for you. But in addition to the credit itself, be aware that the credit also has two features that are especially favorable to small businesses:

  1. Eligible small businesses ($50 million or less in gross receipts) may claim the credit against alternative minimum tax (AMT) liability.
  2. The credit can be used by certain even smaller startup businesses against the employer’s Social Security payroll tax liability.

Let’s take a look at the second feature. Subject to limits, you can elect to apply all or some of any research tax credit that you earn against your payroll taxes instead of your income tax. This payroll tax election may influence you to undertake or increase your research activities. On the other hand, if you’re engaged in — or are planning to undertake — research activities without regard to tax consequences, be aware that you could receive some tax relief.

Why the election is important 

Many new businesses, even if they have some cash flow, or even net positive cash flow and/or a book profit, pay no income taxes and won’t for some time. Thus, there’s no amount against which business credits, including the research credit, can be applied. On the other hand, any wage-paying business, even a new one, has payroll tax liabilities. Therefore, the payroll tax election is an opportunity to get immediate use out of the research credits that you earn. Because every dollar of credit-eligible expenditure can result in as much as a 10-cent tax credit, that’s a big help in the start-up phase of a business — the time when help is most needed.

Eligible businesses

To qualify for the election a taxpayer must:

  • Have gross receipts for the election year of less than $5 million and
  • Be no more than five years past the period for which it had no receipts (the start-up period).

In making these determinations, the only gross receipts that an individual taxpayer takes into account are from the individual’s businesses. An individual’s salary, investment income or other income aren’t taken into account. Also, note that an entity or individual can’t make the election for more than six years in a row.

Limits on the election

The research credit for which the taxpayer makes the payroll tax election can be applied only against the Social Security portion of FICA taxes. It can’t be used to lower the employer’s lability for the “Medicare” portion of FICA taxes or any FICA taxes that the employer withholds and remits to the government on behalf of employees.

The amount of research credit for which the election can be made can’t annually exceed $250,000. Note, too, that an individual or C corporation can make the election only for those research credits which, in the absence of an election, would have to be carried forward. In other words, a C corporation can’t make the election for the research credit that the taxpayer can use to reduce current or past income tax liabilities.

The above are just the basics of the payroll tax election. Keep in mind that identifying and substantiating expenses eligible for the research credit itself is a complex area. Contact us about whether you can benefit from the payroll tax election and the research tax credit.

© 2022

Are you ready for the 2021 gift tax return deadline?

If you made large gifts to your children, grandchildren or other heirs last year, it’s important to determine whether you’re required to file a 2021 gift tax return. And in some cases, even if it’s not required to file one, it may be beneficial to do so anyway.

Who must file?

The annual gift tax exclusion has increased in 2022 to $16,000 but was $15,000 for 2021. Generally, you must file a gift tax return for 2021 if, during the tax year, you made gifts:

  • That exceeded the $15,000-per-recipient gift tax annual exclusion for 2021 (other than to your U.S. citizen spouse),
  • That you wish to split with your spouse to take advantage of your combined $30,000 annual exclusion for 2021,
  • That exceeded the $159,000 annual exclusion in 2021 for gifts to a noncitizen spouse,
  • To a Section 529 college savings plan and wish to accelerate up to five years’ worth of annual exclusions ($75,000) into 2021,
  • Of future interests — such as remainder interests in a trust — regardless of the amount, or
  • Of jointly held or community property.

Keep in mind that you’ll owe gift tax only to the extent that an exclusion doesn’t apply and you’ve used up your lifetime gift and estate tax exemption ($11.7 million for 2021). As you can see, some transfers require a return even if you don’t owe tax.

Why you might want to file

No gift tax return is required if your gifts for 2021 consisted solely of gifts that are tax-free because they qualify as:

  • Annual exclusion gifts,
  • Present interest gifts to a U.S. citizen spouse,
  • Educational or medical expenses paid directly to a school or health care provider, or
  • Political or charitable contributions.

But if you transferred hard-to-value property, such as artwork or interests in a family-owned business, you should consider filing a gift tax return even if you’re not required to. Adequate disclosure of the transfer in a return triggers the statute of limitations, generally preventing the IRS from challenging your valuation more than three years after you file.

The deadline is April 18

The gift tax return deadline is the same as the income tax filing deadline. For 2021 returns, it’s April 18, 2022 — or October 17, 2022, if you file for an extension. But keep in mind that, if you owe gift tax, the payment deadline is April 18, regardless of whether you file for an extension. If you’re not sure whether you must (or should) file a 2021 gift tax return, contact us.

4 levels of audit opinions

The first page of audited financial statements is the auditor’s report. This is an important part of the financials that shouldn’t be overlooked. It contains the audit opinion, which indicates whether the financial statements are fairly presented in all material respects, compliant with Generally Accepted Accounting Principles (GAAP) and free from material misstatement.

In general, there are four types of audit opinions, ranked from most to least desirable.

1. Unqualified. A clean “unqualified” opinion is the most common (and desirable). Here, the auditor states that the company’s financial condition, position and operations are fairly presented in the financial statements.

2. Qualified. The auditor expresses a qualified opinion if the financial statements appear to contain a small deviation from GAAP but are otherwise fairly presented. To illustrate: An auditor will “qualify” his or her opinion if a borrower incorrectly estimates the reserve for a contingency, but the exception doesn’t affect the rest of the financial statements.

Qualified opinions are also given if the company’s management limits the scope of audit procedures. For example, a qualified opinion may have resulted if you denied the auditor access to year-end inventory counts due to safety concerns during the COVID-19 pandemic.

3. Adverse. When an auditor issues an adverse opinion, there are material exceptions to GAAP that affect the financial statements as a whole. Here, the auditor indicates that the financial statements aren’t presented fairly. Typically, an adverse opinion letter outlines these exceptions.

4. Disclaimer. Even more alarming to lenders and investors is a disclaimer opinion. Disclaimers occur when an auditor gives up in the middle of an audit. Reasons for disclaimers may include significant scope limitations, material doubt about the company’s going-concern status and uncertainties within the subject company itself. A disclaimer opinion letter briefly outlines the auditor’s reasons for throwing in the towel.

Beyond the opinion

Auditors’ reports for public companies also must include a discussion of so-called “critical audit matters” (CAMs). Essentially, these are the most complicated issues that arose during the audit. CAMs are specific to the engagement and the year of the audit. As a result, they’re expected to change from year to year.

This requirement represents a major change to the pass-fail audit opinions that have been in place for decades. It’s intended to give stakeholders greater insight into the company’s disclosures and the auditor’s work when issuing an unqualified opinion. Contact us for more information on audit opinions.

Take your financial statements to the next level

Spring is the time of year that calendar-year-end businesses issue financial statements and prepare tax returns. This year, take your financial data beyond compliance. Here’s how financial statements can be used to be proactive, not reactive, to changes in the marketplace.

Perform a benchmarking study

Financial statements can be used to evaluate the company’s current performance vs. past performance or against industry norms. A comprehensive benchmarking study includes the following elements:

Size. This is usually in terms of annual revenue, total assets or market share.

Growth. How much the company’s size has changed from previous periods.

Profitability. This section evaluates whether the business is making money from operations — before considering changes in working capital accounts, investments in capital expenditures and financing activities.

Liquidity. Working capital ratios help assess how easily assets can be converted into cash and whether current assets are sufficient to cover current liabilities.

Asset management. Such ratios as total asset turnover (revenue divided by total assets) or inventory turnover (cost of sales divided by inventory) show how well the company manages its assets.

Leverage. This identifies how the company finances its operations — through debt or equity. There are pros and cons of both.

No universal benchmarks apply to all types of businesses. It’s important to seek data sorted by industry, size and geographic location, if possible.

Forecast the future

Financial statements also may be used to plan for the future. Historical results are often the starting point for forecasted balance sheets, income statements and statements of cash flows.
For example, variable expenses and working capital accounts are often assumed to grow in tandem with revenue. Other items, such as rent and management salaries, are fixed over the short run. These items may need to increase in steps over the long run. For instance, your company may eventually need to expand its factory or purchase equipment to grow if it’s currently at (or near) full capacity.
By tracking sources and uses of cash on the forecasted statement of cash flows, you can identify when cash shortfalls are likely to happen and plan how to make up the difference. For example, you might need to draw on the company’s line of credit, request additional capital contributions, lay off workers, reduce inventory levels or improve collections. In turn, these changes will flow through to the company’s forecasted balance sheet.

We can help

When your year-end financial statements are delivered, consider asking for guidance on how to put them to work for you. We can help you benchmark your results over time or against industry norms and plan for the future. Contact us for more information.

You’re Selling Your Business?

Selling your business can be a bittersweet experience. While you may be excited for the future, it’s the end of an era. Be sure you don’t overlook these considerations.

STAY INSURED

You’ll still need health insurance, which you’ll likely have to pay for on your own. Also, review your disability and life insurance needs. Policies that your company used to pay for will now have to come out of your pocket.

TAX SAVINGS

Work with your tax professional to create a plan to minimize the taxes you’ll owe from the sale. That could include making donations to your favorite charity, gifting money to children and grandchildren or setting up a donor-advised fund.

FREEDOM PLANNING

If you’re retiring, planning for your new free time is just as important as the financial decisions you’ll need to make. Without the routine of working, you may feel lost. Take ample time to prioritize how you want to fill your days to stave off boredom and loneliness. You may find that it takes a year or more to settle into a new routine.