Using Research Credits to Reduce Payroll Taxes
The IRS issued guidance for small business annual tax filers that want to claim a research credit against their payroll tax liability. The IRS stated that computing the tax credit for annual employment tax filers if the income tax return electing the credit is filed during the first three quarters of the calendar year because the information on Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, is compiled on an annual basis.
Here’s the back story.
After December 31, 2015, then-President Obama signed into law the Protecting Americans from Tax Hikes (PATH Act of 2015, which included changes for qualified small businesses to claim up to $250,000 of its credit for increasing research activities as a payroll tax credit against the employer’s share of social security tax. Prior to 2016, small businesses could only take the research tax credit against income tax liability.
What type of business is eligible?
The business must be a sole proprietorship, a partnership or a corporation whose stock isn’t publicly traded. The average annual gross receipts of the business for the 3-tax-year period preceding the tax year of the credit cannot exceed $50 million. If the entity was not in existence for the entire three-year period, then the gross receipts requirement is based on the period during which the entity was in existence.
As a qualified business with qualifying research expenses, you can apply up to $250,000 of your research credit against your payroll tax liability by using the following steps:
- Complete Form 6765, Credit for Increasing Research Activities, make the election, and attach the completed form to your timely filed business income return.
- Claim the payroll tax credit by completing Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. You must attach this form to your payroll tax return.
Note: The amount reported on form 8974, Line 10 is the total amount of social security tax (both employer and employee shares) for the whole year, but employers can only apply the credit against the employer share of the social security tax paid in calendar quarters that began after the date on which the business files it income tax return making the election. Since you can’t apply for the credit during a time when you filed your tax return, you can take a partial credit adjustment on Form 8974, line 11 to be 50% of the total social security tax that you paid in the quarters after the income tax return making the election was filed. If you don’t consult with a small business tax expert or a payroll service, this would be a great time to have a chat with one.