How small businesses can apply the research credit to payroll taxes

Interim guidance addresses the time and manner of making the election.
By Alistair Nevius, J.D.

The IRS issued interim guidance on how eligible small businesses can take advantage of a new provision that allows them to apply part or all of their Sec. 41 research tax credit against their payroll tax liability instead of their income tax liability. Before 2016, taxpayers could only take the research credit against their income tax liability.

Under Secs. 41(h) and 3111(f), enacted by the Protecting Americans From Tax Hikes (PATH) Act of 2015, P.L. 114-113, a qualified small business can elect to apply a portion of its Sec. 41 research credit against the employer portion of Federal Insurance Contributions Act (FICA) payroll taxes, effective for tax years beginning after Dec. 31, 2015. To be a qualified small business for a tax year, a business must have gross receipts of less than $5 million for the year and must not have had gross receipts for any tax year before the five-tax-year period ending with the year.

An eligible small business with qualifying research expenses can elect to apply up to $250,000 of its research credit against its payroll tax liability by filing Form 6765, Credit for Increasing Research Activities, with its timely filed business income tax return. Under a special rule for tax year 2016, a small business that has already filed its 2016 return and failed to choose this option can still make the election by filing an amended return by Dec. 31, 2017.

A small business then claims the payroll tax credit by filing Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. This form must be attached to the business's payroll tax return.

  • Notice 2017-23

—By Alistair Nevius, J.D., the JofA's editor-in-chief, tax.

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