The research and development (R&D) tax credit was made permanent in December 2015 as part of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), allowing businesses to offset their federal tax liability.
Under the same provision, qualified small businesses and startups are eligible to utilize the R&D credit to offset up to $250,000 of the employer portion of payroll taxes each year. However, amid some confusion about who qualifies and other details of the provision, the IRS issued interim guidance that describes how eligible small businesses can apply all or part of their research credit against their payroll tax liability. To help clients, prospects and others understand how to take advantage of this benefit, Hanson & Co. has provided the key details below.
What is a “Qualified Small Business”?
A qualified small business is defined as a corporation, partnership or individual with less than $5 million in gross receipts during the tax year in which the credit is claimed and with no gross receipts for any tax year preceding a five-year window. For instance, to claim the credit on a 2017 tax return, the business must have less than $5 million in gross receipts during 2017 and could not have had any gross receipts prior to 2013.
Definition of “Gross Receipts”
The definition of a qualified small business creates an additional question about how the IRS defines gross receipts. The PATH Act states, “gross receipts for any taxable year shall be reduced by returns and allowances made during such year.” The interim guidance has expanded the definition to include total sales, interest, dividends, rents, royalties and annuities, which could actually limit the amount of companies that can qualify as a small business.
The interim guidance also provides special rules for controlled groups, which are corporations under common control (e.g., a parent-subsidiary or two companies owned by the same parent company). Each member of a controlled group can separately make the payroll tax credit election. Regardless of whether each member in the controlled group makes the election, the $250,000 amount is allocated to each member in the same proportion as the group’s research credit.
Correct Election Timing
The PATH Act originally stipulated that the payroll tax credit election must be made on a timely filed return (including extensions) – not on an amendment. The interim guidance has revised this statement to say that taxpayers can amend their return to make the payroll tax election if the amendment is filed on or before 12/31/17.
For qualified small businesses that file quarterly employment tax returns, they should claim the payroll tax credit on their employment tax return for the first quarter that begins after the income tax return is filed. For instance, if their 2016 income tax return was filed on April 15, 2017 with the payroll tax credit election reflected appropriately, the business would claim the payroll tax credit for the third quarter of 2017. Businesses that file annual employment tax returns will claim the payroll tax credit on the annual return that includes the first quarter beginning after they file the income tax return reflecting the election.
The information issued to date is considered interim guidance. The IRS is accepting feedback and has requested any comments regarding the notice or other issues affecting payroll tax credit elections by July 17, 2017.
Certain small businesses and start-up companies that qualify for the R&D credit have a significant opportunity for additional savings as part of the payroll tax credit election. If you have questions or want to discuss whether your company qualifies, Hanson & Co. can help! For more information, please call us at (303) 388-1010 or click here to contact us. We look forward to speaking with you soon.