Further Guidance for Research Tax Credit Payroll Offset Timing and Procedures
Under the Protecting Americans from Tax Hikes (“PATH”) Act of 2015, eligible small businesses may elect to utilize up to $250,000 of the Research Tax Credits (R&D tax credit) they generate under Internal Revenue Code section 41 after 2015 against their portion of payroll taxes, i.e., Federal Insurance Contributions Act (“FICA”) taxes. On July 31, 2017, the Internal Revenue Service (“IRS”) released generic legal advice memo (AM 2017-003) to provide further guidance, addressing timing issues associated with how small start-up businesses can apply the R&D tax credit against their payroll tax liability.
An eligible small business may use the R&D tax credit to offset employer social security tax liability the quarter after filing its income tax return with appropriate elections. The credit may be taken to the extent of employer social security tax on wages associated with the first payroll payment, and then to the extent of employer social security tax associated with succeeding payroll payments in the quarter until the credit is used. If any payroll tax credit amounts remain at the end of the quarter, the excess credit may be carried over and treated as a payroll tax credit for the succeeding quarter.
In determining the amount to enter on the Record of Federal Tax Liability with respect to a payment of wages subject to social security tax, the employer should reduce tax liability by the lesser of the amount of employer social security tax on the wages or the available payroll tax credit.
If an employer did not elect the payroll tax credit on their timely filed original, federal tax return and wishes to file an amended return to claim it, they may do so on the employment tax return for the quarter beginning after the filing of the amended income tax return. The income tax return amendment must be filed on or before December 31, 2017, and the credit cannot be applied to an earlier quarter of filing.
The guidance also notes that should a taxpayer file an income tax return properly electing the payroll tax credit in one quarter, but in the following quarter mistakenly fail to take account of the payroll tax credit in determining its deposits and in filing Form 941, it should file a Form 941-X for that following quarter with appropriate form attachments claiming the appropriate credit.
General Procedure for Adjusting Payroll Tax Liability for the Research Tax Credit
- Step 1: Calculate the employer social security tax included in the liability to be reported on Form 941 Line 16 for monthly depositors, or Schedule B for semi-weekly depositors, on the first date wages are paid for the quarter.
- Step 2: Compare that amount of employer social security tax on the wages paid for the first pay date to the amount of payroll tax credit available for that quarter.
- Step 3: Deposit, in a timely manner, the amount of the reported liability for (a) the amount of employer social security tax that cannot be offset by the payroll credit, (b) the amount of employee social security tax, (c) the amount of employer Medicare tax, (d) the amount of employee Medicare tax, and (e) the amount of income tax withholding.
- Step 4: If any credit is being carried over to a proceeding quarter, a Form 8974 will be required for each quarter—or year, if filing an annual employment tax return. Repeat these steps until the credit is fully utilized. Taxpayers are encouraged to consult with their payroll provider for further instructions.
With this new guidance, taxpayers now have certainty in electing and utilizing R&D tax credits to offset their payroll tax. Allowing small businesses and startups to benefit from the R&D tax credit regardless of whether they pay income taxes frees up private capital and enables investment in resources to facilitate the development of new or improved technologies.
For questions related to the Research Tax Credit, please contact us.
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