The Inflation Reduction Act of 2022 ("IRA") has increased and modified the qualified small business payroll tax credit for increasing research activities. Here are some basic facts about the payroll tax credit and how employers may claim the credit. About the Qualified Small Business Payroll Tax Credit for Increasing Research Activities IRC 41, Credit for Increasing Research Activities, allows taxpayers a credit against income tax for increasing research activities ("research credit"). Generally, the research credit is equal to the sum of 20 percent of the excess (if any) of the taxpayer's qualified research expenses ("QREs") for the taxable year over the base amount. Taxpayers may elect to determine their credit under the alternative simplified credit (ASC) rules of IRC 41(c)(4), where the credit is equal to 14 percent of the QREs for the taxable year over 50 percent of the average QREs for the 3 taxable years preceding the credit year. The research credit is calculated on Form 6765, Credit for Increasing Research Activities, and is generally applied against a taxpayer's income tax liability. The Protecting Americans from Tax Hikes (PATH) Act of 2015 enacted IRC 41(h) and 3111(f), which allow a qualified small business ("QSB") to elect to apply a portion of the research credit for the taxable year as a payroll tax credit against the employer portion of the old-age, survivors, and disability insurance tax ("social security tax") under the Federal Insurance Contributions Act. This election is designed to benefit an eligible startup that has little or no income tax liability. The payroll tax credit is elected by completing the appropriate portion of Form 6765PDF and attaching the completed form to the QSB's timely filed (including extensions) income tax return for the taxable year to which the election applies. An election cannot be made with an amended return. The QSB can first claim the payroll tax credit on its employment tax return for the first quarter that begins after it files the income tax return reflecting the payroll tax election on Form 6765 election. A QSB claiming the payroll tax credit on its employment tax return must complete Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, and attach the completed form to the employment tax return. For taxable years beginning after December 31, 2015, and before January 1, 2023, the maximum research credit that could be elected in a tax year to be applied toward payroll taxes was $250,000. The. The credit could be applied against the employer's share of social security tax, as imposed by IRC 3111(a), beginning with the first quarter that begins after the timely filing of the return on which the election was made. For employment tax returns covering taxable years beginning before January 1, 2023, the taxpayer 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 the employer's portion of social security tax. For more information on the research credit itself, see the Instructions for Form 6765, Credit for Increasing Research ActivitiesPDF. Provision 13902 of the IRA of 2022 increased the maximum amount of payroll tax research credit that a QSB can elect to apply against payroll tax liability from $250,000 to $500,000 for tax years beginning after December 31, 2022. The IRA also modified IRC 3111(f) to allow a portion of the payroll tax credit to apply against the employer's portion of Medicare tax, as imposed by IRC 3111(b). Therefore, starting in the first quarter of 2023, the payroll tax credit is first used to reduce the employer's share of social security tax up to $250,000 per quarter and any remaining credit reduces the employer's share of Medicare tax for the quarter. Any remaining credit, after reducing the employer's share of social security tax and the employer's share of Medicare tax, is then carried forward to the next quarter. Form 8974PDF is used to determine the amount of the payroll tax credit that can be used in the current quarter. Generally, for new payroll tax credit elections for tax years beginning after December 31, 2022, made on Forms 6765 attached to timely filed (including extensions) income tax returns, a QSB claims the payroll tax credit against employer social security and employer Medicare tax liabilities beginning with the first calendar quarter beginning after the date the income tax return reflecting the election is filed. A short tax year filer may be able to make an election on a Form 6765 attached to an income tax return filed in 2023. After filing its income tax return reflecting the election on Form 6765, the short year filer would then claim the payroll tax credit with the first calendar quarter that begins after the date the income tax return is timely filed (including extensions). This may result in the payroll tax credit applying to a 2023 employment tax return. For older elections that are carried over into 2023, the carryover amount can now be applied against the employer's share of social security tax (up to $250,000) and then to the employer's share of Medicare tax for employment tax returns. For both new elections and carryover elections, a payroll tax credit in excess of the employer's share of social security tax and employer's share of Medicare tax shown on an employment tax return may be carried over to the next period's employment tax return. For more information on the changes to the payroll tax credit and how it is computed and applied to employment tax returns, see the Instructions for Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. Notice 2017-23 provides interim guidance for determining eligibility for and making the payroll tax credit election and claiming the payroll tax research credit. Qualified Small Business Employer Filing Under Your 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, PDF 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, then 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 8974PDF. 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 can be found at About Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. Aggregate Filers Filing On Behalf Of Clients/Customers If you are a Section 3504 agent or a Certified Professional Employer Organization (CPEO), then 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), then 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).
