The 2018 Farm Bill removed industrial hemp and hemp-derived CBD (defined as containing less than 0.3% THC) from the list of controlled substances. This move was heralded by many in the industry as a necessary (and long overdue) change to the current law. Because they are no longer considered controlled substances, companies operating in the industrial hemp/CBD arenas can now take advantage of the many deductions and tax credits available to all legitimate businesses, including the R&D tax credit.
The R&D tax credit is a dollar-for-dollar reduction in income tax liability based on a company's investments in research and development. Basically, if you are creating a new product or improving on an existing one, your activities most likely qualify. For a detailed review of the R&D tax credit and what qualifies as research and development, see our article on How Hemp and Hemp-Derived CBD Businesses Can Leverage the R&D Tax Credit.
Here is a general example to illustrate the benefits of claiming the R&D tax credit. You own a medium-sized hemp farming operation with $1 million in qualified research expenses (QREs) (the sum of qualified employee wages, raw materials and supplies, and third-party contractors involved in research and development). The federal R&D tax credit is calculated at roughly 10%, translating to a $100,000 tax credit towards your federal income tax liability. This is an amazing benefit for a company that is profitable and paying taxes. But what if you are involved in a startup or your company is not paying taxes just yet? For companies with no tax liabilities, there is another way the R&D tax credit can be of benefit: it can offset the amount of payroll taxes your company pays.
Payroll taxes are taxes a company pays on the wages and salaries of its employees. These taxes finance social programs, e.g. Social Security and Medicare. The rate for the Social Security portion of this is 12.4% (this becomes relevant later). Half of payroll taxes are paid directly to the IRS by the company, the other half by the employees. The amount a company owes in payroll taxes can be significant, depending on how many employees a company has on its payroll. How does the R&D tax credit reduce this amount?
Taking the same example from above, your company now has $100,000 in federal R&D tax credits, but cannot use them because it does not owe any taxes. Let’s say your company has 10 employees and a total annual payroll of $750,000. This translates to your company owing $46,500 a year in Social Security taxes to the IRS ($750,000 x 6.2% [half of 12.4%] = $46,500). This is $11,625 owed per quarter. When you apply your $100,000 credit, it results in more than eight quarters (>2 years) of Social Security tax your company does not have to pay. This is money that can be reinvested into your business to improve infrastructure, spur growth, and support continued innovation.
Qualified Small Businesses (QSBs) and startup companies that are eligible for the payroll tax credit are companies that have:
Companies that meet these three criteria can elect up to $250,000 per year of their Federal R&D Tax Credit to offset their payroll taxes, for the first five years of revenues.
In whatever quarter your company files its income tax returns, it can start claiming payroll tax benefits in the following quarter. For example, if your company files its tax return in Q2 and claims the R&D Tax Credit, you are able to start offsetting your payroll tax in Q3.
This is free money from the IRS to reward companies performing U.S.-based research and development. The industrial hemp and hemp-derived CBD industries are in their relative infancy. As such, a majority of expenses incurred by these businesses in the first few years are likely geared toward new products, processes, and innovations. This makes many companies operating in this space prime candidates to offset payroll tax liabilities with the R&D tax credit.
HempTax specializes in helping hemp and hemp-related businesses maximize their tax savings. Want to learn more? See our detailed FAQs on the R&D tax credit for hemp and CBD industries. Or contact a HempTax advisor today to see if your company qualifies, and if so, how much you could be saving.
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