R&E Tax Credit Changes

Do Changes in the R&E Tax Credit Warrant Reclassification of Workers?

In the recent tax bill, Congress changed the research and experimentation credit of Code Section 41, making it permanent and more accessible to early-stage companies. The R&E credit is generally available to businesses that conduct “research or experimental expenditures” (as defined in Treasury regulations), but has historically been of little benefit to early-stage businesses lacking taxable income.

However, new Code Section 41(h) allows most small businesses to apply the R&E tax credit against their employer share of payroll — or, FICA — taxes. Lacking taxable income, many early-stage businesses pay only federal payroll taxes, so this change could substantially reduce overall federal taxes for research-intensive growth companies. Early-stage technology companies that characterize workers as independent contractors (perhaps, improperly) may want to consider this incentive as the “carrot” intended to encourage reclassification as employees.