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 (“RTCs”) they generate under Internal Revenue Code section 41 and after 2015 against their portion of payroll—i.e., Federal Insurance Contributions Act (“FICA”)—taxes. On March 28, 2017, the Internal Revenue Service (IRS) released Notice 2017-23 to clarify small business eligibility and how the offset is applied. It also enables taxpayers who didn’t make the election on their 2016 tax returns to amend it and claim the benefit.
In order to qualify as an “eligible small business,” a taxpayer must have (1) gross receipts of less than $5 million in the year in which it seeks to make the election and (2) no gross receipts for any tax year before the five years ending with the election year, e.g., before 2012 if the election year were 2016. The notice clarifies that “gross receipts” here includes total sales, net of returns and allowances, all amounts received for services, and any income from investments and other incidental or outside sources. This inclusive definition means that taxpayers with even small amounts of investment income or interest prior to 2012 may not elect the payroll offset. This is significant because it limits taxpayer eligibility, specifically for companies that had been in existence prior to 2012.
Taxpayers can benefit from the payroll offset in the first calendar quarter after filing their tax returns. The Notice explains that if the RTC exceeds the payroll tax due on a quarterly filing, the excess may be carried over to succeeding calendar quarters until the credit is used or the $250,000 limit is reached. In addition, the Notice enables taxpayers who failed to elect the payroll offset on their original returns for 2016 to take advantage of the provision by filing an amended return on or before December 31, 2017. The Notice provides specific filing instructions as it relates to amending returns to retroactively make this election.
Finally, the Notice provides guidance for members of a controlled group or group regarding aggregation and allocation of the benefit and requests public comment on other payroll tax credit issues to be addressed in future guidance.
With the new interim guidance, taxpayers now have more certainty in electing RTCs to offset their payroll tax starting in tax year 2016. Allowing small businesses and startups to benefit from the RTC regardless of whether they pay income taxes frees up private capital and enables investment in resources to facilitate new or improved technologies.