On March 30, 2017, the Internal Revenue Service issued interim guidance explaining how Qualified Small Businesses can take advantage of a new option enabling them to apply part or all of their R&D tax credit against their payroll (FICA) tax liability. Here are some highlights of the recently released guidance.
On December 18, 2015 under the Protecting Americans from Tax Hikes (“PATH”) Act of 2015, the federal Credit for Increasing Research Activities (“R&D tax credit”) was permanently extended by Congress. In addition to the permanency of the credit, the PATH Act allows a Qualified Small Business (“QSB”) to claim the R&D tax credit as an offset to the employer portion of FICA payroll tax up to $250,000 for each eligible year. Previously taxpayers could only take the R&D tax credit against income tax liability. The payroll tax credit offset is effective for taxable years beginning after December 31, 2015. Under §41(h)(4)(B)(ii), a taxpayer may use the payroll tax offset up to a maximum of 5 years.
Defining a Qualified Small Business (“QSB”)
A QSB means, with respect to any taxable year, if the gross receipts of such entity for the taxable year are less than $5,000,000, and the entity did not have gross receipts for any taxable year preceding the 5-taxable-year period ending with such taxable year.
- For tax year 2016, gross receipts must be less than $5,000,000 with zero gross receipts before 2012.
Definition of Gross Receipts
The term “gross receipts” means gross receipts as determined under §448(c)(3) (without regard to §448(c)(3)(A)) and §1.448-1T(f)(2)(iii) and (iv) of the Income Tax Regulations). The definition of gross receipts under §41(c)(7) and §1.41-3(c) does not apply for purposes of §41(h).
- This definition includes investment income in gross receipts including interest income.
Electing the Payroll Tax Credit on an Original Return
A QSB makes a payroll tax credit election by completing the appropriate portion of Form 6765, Credit for Increasing Research Activities, relating to the payroll tax credit election, and attaching the completed form to the QSB’s timely filed (including extensions) return for the taxable year to which the election applies.
Electing the Payroll Tax Credit on an Amended Return
If a QSB timely files its return for a taxable year beginning after December 31, 2015, but fails to make the payroll tax credit election, it may make the election on an amended return filed on or before December 31, 2017. To qualify for this extension, the business must either:
- Indicate on the top of its Form 6765 reflecting the payroll tax credit election that the form is “FILED PURSUANT TO NOTICE 2017-23,” OR
- Attach a statement to its Form 6765 reflecting the payroll tax credit election that the form is filed pursuant to Notice 2017-23
The payroll tax credit is allocated to each member of a controlled group in the same manner as the group’s R&D tax credit is allocated under §1.41-6T(c).
Carryforward of the Payroll Offset
The payroll tax credit claimed by an employer on an employment tax return cannot exceed the employer portion of the social security tax for any calendar quarter. If the payroll tax credit elected on Form 6765 exceeds this limitation, then the excess is carried over to the succeeding calendar quarter(s) and allowed as a payroll tax credit for the succeeding quarter(s), subject to the social security tax limitation applicable to the quarter(s).
Request for Comments
The Treasury Department and the IRS are requesting comments on various payroll tax credit issues to be addressed in future guidance. Comments are requested by July 17, 2017. Refer to Notice 2017-23 for additional details for submission.
In light of the recent changes and additional guidance, taxpayers who were unable to utilize federal R&D credits previously due to Alternative Minimum Tax (“AMT”) or Net Operating Loss (“NOL”) limitations, should reevaluate their eligibility to take advantage of these incentives.
For additional information on this issue, you can read more on the IRS website.