IRS Announces Guidance on Refundable Payroll Taxes of Research and Development Tax Credit Claims

UPDATE: Please refer to our updated article, “New Businesses or Start-Ups: Get Ready for the New Research and Development Credit Payroll Tax Offset” for further details.

The IRS recently announced guidance regarding filing, claiming and reporting requirements related to the refundable Payroll Tax Credit provisions of the Research and Development (R&D) tax credit for Qualified Start-up Businesses. The credit was introduced as part of the Protecting Americans from Tax Hikes Act of 2015 (commonly called the “PATH Act”) which was signed into law on December 18, 2015. (Marcum issued a Tax Flash on the many favorable tax provisions in the Act.)

The new Payroll Tax Credit refund component of the R&D provision became effective January 1, 2016, and allows qualified small businesses to elect to utilize the R&D tax credit to refund employer-paid FICA tax liability. A qualified small business is defined as a Corporation, Partnership, LLC or Sole Proprietorship which is less than five years old, with less than $5 million in annual gross receipts in each of the preceding five years. The Payroll Tax Credit will be refundable up to $250,000 in payroll taxes per year. Any excess credit can be carried forward to future years.

This payroll tax credit provision will provide a significant refund opportunity for qualified small businesses. Many small businesses with research and development operations do not pay significant income taxes during the start-up and growing phases. However, almost all small businesses have payroll tax liabilities which now may be reduced by claiming the credit.

The IRS released preliminary guidance related to the Payroll Tax Credit. Qualifying start-up businesses eligible for the Payroll Tax Credit can expedite the refund application process via claimant reporting on Form 8974—Qualified Small Business Payroll Tax Credit, which will flow through to the employer’s federal quarterly tax return (Form 941) on line 11 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities). Guidance has yet to be provided regarding the time sensitivity of Form 8974 filing.

The reporting guidance allows taxpayers to expedite Employer FICA reimbursement of employer tax paid throughout the year in lieu of applying for credits by filing federal tax returns on business Forms 1120, 1120S and 1065. The Qualified Small Business Payroll Tax Credit also expands taxpayers’ ability to fully utilize the R&D Tax Credit by allowing employers to split the overall R&D credit between payroll and federal taxes. The IRS will announce formal guidance later this year.

The Internal Revenue Service has also released drafts of the 2017 Form 941 (Employer Quarterly Federal Tax Return) and 2016 Form 6765 (Credit for Increasing Research Activities) to accommodate the new Research and Development tax credit reporting requirements for comments before final release. Draft forms cannot be used for filing purposes per IRS guidelines. Final forms will be released at later date.

The R&D Credit is wide-ranging and is available to businesses in most industries, including but not limited to:

• Manufacturing.
• Software design.
• Financial and professional services.
• Technology.
• Construction.

The R&D Credit is primarily a wage and consulting fee-based credit pertaining to employees and contractors who perform, directly support or directly supervise qualified research activities performed in the U.S.

The qualified research activities eligible for the credit must meet the following requirements:

• Must be technological in nature.
• Must be for a permitted purpose.
• Technical uncertainty must be eliminated.
• Must involve a process of working through the technical uncertainty.

Success of development is not necessary for the expenses to qualify. Time incurred related to delays, redesigns and failures are all great examples of eligible R&D costs. Patents and applications are also excellent support for R&D.

Based on these changes and the new permanence of the credit, this is an optimum time for all businesses to reevaluate the potential benefit they might derive from the R&D tax credit.

Marcum LLP has a team of tax professionals dedicated to R&D Credits and Incentives. Contact your Marcum Tax Advisor to arrange a review of your business to determine eligibility.