When Congress permanently extended the credit as part of the Protecting Americans from Tax Hikes Act (PATH) of 2015, it included a new option for qualified startup companies to offset payroll taxes.
Since its inception in the 1980s, the research credit has expired, been reinstated, and been modified several times. Currently, the credit is equal to the sum of the following:
Twenty percent of the excess of qualified research expenses for the year over a base amount.
The university basic research credit (i.e., 20 percent of the basic research payments).
Twenty percent of the qualified energy research expenses undertaken by an energy research consortium.
Alternatively, a company may elect a simplified research credit equal to 14 percent of the amount by which qualified expenses exceed 50 percent of the average for the three preceding tax years. In either case – with the regular credit or the simplified credit – a business can offset its income tax bill on a dollar-for-dollar basis.
Prior to the PATH Act, the credit could only be used to offset income tax, just like most tax credits. However, the legislation allows a qualified small business to apply up to $250,000 of its research credit against payroll tax liability.
To qualify for this new option for the current tax year, the business must have gross receipts of less than $5 million and could not have had gross receipts prior to 2012. The change is effective for the 2016 tax year.
The IRS instructs firms to fill out Form 6765, Credit for Increasing Research Activities, and attach it to a timely business income tax return. Because many business taxpayers request a tax-filing extension, they still have time to make this choice on a 2016 return. Note: A number of special rules and computations apply to the credit.
For eligible small businesses that already filed and failed to choose this option, there still is time to cash in. Under a special rule for the 2016 tax year, the IRS says a business can file an amended return by Dec. 31, 2017.
Amended return forms vary depending upon the type of business.
Sole proprietors file Form 1040X.
Regular corporations file Form 1120X.
S corporations file Form 1120S, identifying it as a corrected return (box H(4)).
After choosing this option, either on an original or amended return, a small business claims the payroll tax credit by filling out Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. This form must be attached to its payroll tax return, usually Form 941, Employer’s Quarterly Federal Tax Return.
Further details on how and when to claim the credit are contained in Notice 2017-23. The notice also provides interim guidance on other technical issues, such as controlled groups and the definition of gross receipts.
This could be a significant opportunity for small business owners. Accountants and Tax Professionals should review their situation to determine if they qualify for the special election before year-end.