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 against their payroll tax liability. This new option is available to eligible small businesses for tax years beginning after 2015. On March 28, 2017, the Internal Revenue Service (“IRS”) released Notice 2017-23, which clarifies small business eligibility requirements and details how the offset is applied. The Notice also stipulates that taxpayers who did not make the election on their 2016 tax returns may amend it to 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” in this capacity include 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 also provides specific filing instructions as it relates to amending returns for the purpose of retroactively making 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 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.