By Erika Diebert, Tax Senior
There is an opportunity for Qualified Small Businesses (QSBs) to utilize their unused federal 2016 R&D credits against their 2017 payroll tax liability (Employer portion of FICA). This was enacted as part of the PATH Act of 2015 but is just now becoming available starting with the income tax filings for the 2016 tax year.
The offset of payroll taxes will be available for R&D credits generated on the 2016 tax return from R&D expenses incurred in 2016. R&D credit carryovers from years prior to 2016 cannot be used. The maximum benefit allowed to be claimed in a tax year is $250,000. An election to use the credit against payroll taxes is made on an originally and timely filed (including extensions) Form 6765 by completing section D of the form.
For C corporations, the credit available to offset payroll taxes is limited to the amount of the R&D credit not otherwise utilized on the 2016 return. For pass-through entities, the election to offset payroll taxes is made at the entity level. If made, the R&D credit passed through to shareholders and partners will be reduced. As a practical note, pass-through entities have a choice of whether to take this benefit at the entity level or pass the credit on to the owners. Therefore, should be given to which alternative yields the better result.
“QSBs” are defined as companies that:
- Have had no gross receipts for any tax year preceding the 5 year period ending with the election year. For 2016, companies must not have had gross receipts prior to 2012.
- Have less than $5 million in gross receipts in the year the election is made. Currently, that would be the year 2016.
The payroll tax offset will be available on a quarterly basis and can be applied only against the employer portion of FICA payroll taxes. This begins with the first calendar quarter after the business files its 2016 federal income tax return. For example, the business would need to file its federal income tax return by March 31, 2017, to apply the credit against their second quarter payroll tax liability. In this case, the benefit of the credit would be realized in July of 2017 when the business files their second quarter 941 payroll tax return. Please note you cannot use the credit to reduce amounts paid in during the quarter. The business must wait until the Form 941 is filed to claim the credit.
The IRS has released a draft of the 2017 Form 941. There is a new line where the tax reduction can be claimed. There will also be a new form 8974 used to reflect information regarding the credit that will be required to be attached to Form 941.
For those using payroll services to complete Form 941, there will have to be some communication related to this credit. For businesses using PEOs (Trinet, ADP, etc.) the client will still be considered the employer for purposes of applying the credit. We have received word from PEO’s that, although they are aware of the credit, they do not have a process in place currently to allow for the claiming of this credit. They are waiting for the forms and official guidance to be finalized by the IRS. They have advised their clients to extend their 2016 tax returns if they are planning to claim the credit. So if your business uses a PEO or payroll service you will want to ask your provider what their timeline will be for processing these claims.
The IRS is still working on guidance and the related forms to facilitate claiming the offset. Additionally, a number of practical questions remain to be answered to fully understand the mechanics and implications of making the election. However, if eligible, this credit creates a great opportunity to utilize unused R&D credits to generate cash flow in the near future.