Qualified Small Business Payroll Tax Credit for Increasing Research Activities

Notice 2017-23  provides interim guidance on the payroll tax credit, a provision of the Protecting Americans From Tax Hikes Act (enacted in December 2015) that was first made available to qualified small businesses filing 2016 federal income tax returns whose business tax year began after December 31, 2015.  The notice explains whether your business is a qualified small business eligible to elect the payroll tax credit. As a qualified small business, you may apply part or all of your research credit against your payroll tax liability, instead of your income tax liability.  Before 2016, you could only take the research credit against your income tax liability. The payroll tax credit election may especially benefit eligible startup businesses having little or no income tax liability.

The payroll tax credit can apply only against your qualified small business’ liability for the employer portion of social security tax, as imposed by section 3111(a) of the Internal Revenue Code. You may not use the payroll tax credit as a credit against any other employment tax liability and the credit may not be refunded in the absence of liability for your employer social security tax. For more information on the research credit itself, see the Instructions  for Form 6765, Credit for Increasing Research Activities.

Qualified Small Business Employer Filing Under Own EIN

As a qualified small business with qualifying research expenses, you can apply up to $250,000 of your research credit against your payroll tax liability by taking the following steps:

Step 1: Complete Form 6765, Credit for Increasing Research Activities, make the election, and attach the completed form to your timely-filed business income tax return.

Note: If you, as a qualified small business, already filed your 2016 tax return, you may still choose this option under a special rule for tax year 2016, by filing an amended return by December 31, 2017. See the notice for further details.

Step 2: 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, for example, your Form 941, Employer’s Quarterly Federal Tax Return. Further details on how and when to claim the credit are in the notice.

Aggregate Filers Filing On Behalf Of Clients/Customers

If you are a Section 3504 agent or a Certified Professional Employer Organization (CPEO), you may claim the payroll tax credit on behalf of a qualified small business client that elects to apply the research credit against payroll tax liability.  For you to claim the credit, your client must be a qualified small business and must elect to apply the research credit against payroll tax liability by attaching Form 6765 to its timely-filed business income tax return.  To claim the credit on behalf of a client:

Step 1: Claim the Qualified Small Business Payroll Tax Credit for Increasing Research Activities on a Form 941 filed under the Section 3504 agent’s or CPEO’s Employer Identification Number (EIN).

Step 2: Complete and attach Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, when filing an aggregate Form 941.

Step 3: Attach a Form 8974 for each qualified small business client opting to apply the research credit against payroll tax liability.

If you are a Non Certified PEO (including CPEO applicants not yet certified) that pays wages to individuals as part of the services provided to a client pursuant to a service agreement, such as collecting, reporting and/or paying or depositing employment taxes with respect to such wages, you may claim the payroll tax credit on behalf of a qualified small business client.  For you to claim the credit, your client must be a qualified small business and must elect to apply the research credit against payroll tax liability by attaching Form 6765 to its timely-filed business income tax return.  To claim the credit on behalf of a client:

Step 1: Claim the Qualified Small Business Payroll Tax Credit for Increasing Research Activities on a Form 941 filed under the PEO’s EIN.

Step 2: Complete and attach Schedule R (Form 941) listing those clients electing to claim the Qualified Small Business Payroll Tax Credit for Increasing Research Activities and report the corresponding credits and all other amounts allocated to the listed clients. Check the ‘Section 3504 Agent’ box for ‘Type of filer’ at the top of the Schedule R. Enter the total wages and taxes paid for all other clients not separately listed on Schedule R and for your own employees on line 13 of Schedule R, so that the totals shown on line 14 match the amounts reported on the corresponding lines on Form 941.

Note: This required step for Non-Certified PEOs provides the necessary substantiation to enable the IRS to apply each client’s research credit against the payroll tax liability reported on Form 941 under the PEO’s EIN.

Step 3: Complete and attach Form 8974 for each client listed on Schedule R (Form 941).