United States

IRS addresses timing issues related to payroll tax research credit

TAX ALERT  | 

There has been much confusion regarding the new payroll tax credit for research and development (R&D) for qualified small businesses. Recent IRS guidance should be helpful in clarifying additional areas of uncertainty as a result of these new provisions.

IRS Office of Chief Counsel released a Legal Memorandum on July 31, 2017 addressing timing issues related to offsetting the employer portion of social security tax with research and development (R&D) credits. While the advice may not be used or cited as precedent, it is an indication of the IRS’ position (including examples) on how and when taxpayers may use R&D tax credits for payroll tax offset.

General Guidelines

Effective for tax years beginning after Dec. 31, 2015, sections 41(h) and 3111(f) allow a qualified small business (taxpayer) to apply a portion of R&D credits against the employer portion of social security tax. A taxpayer makes a payroll tax credit election by completing the appropriate portion of Form 6765 (Credit for Increasing Research Activities), and attaching the completed form to the taxpayer’s timely filed (including extensions) return for the taxable year to which the election applies.

The taxpayer may offset payroll taxes beginning with the first calendar quarter that begins after the date the taxpayer files the return, provided the taxpayer later files Form 8974 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities), with Form 941 (Employer’s Quarterly Federal tax Return) or other employment tax return for the quarter.

Payroll tax credits cannot exceed the employer portion of social security tax imposed for all employees during a calendar quarter, and any excess is carried to the succeeding calendar quarter and allowed as a payroll tax credit for that quarter.

The Memorandum addresses two issues

Q1. When should an employer take into account the payroll tax credit for purposes of determining its daily tax liability and deposit liability on Form 941, Schedule B (Report of Tax Liability for Semiweekly Schedule Depositors)?

A1. With the first payroll payment of the quarter that includes payments of wages subject to social security tax. In determining the amount to enter on the Record of Federal tax Liability, the employer should reduce tax liability by the lesser of: (A) the amount of the employer social security tax on the wages or (B) the available payroll tax credit. If any payroll tax credit is remaining at the end of the quarter because it exceeds the amount of employer social security tax on wages paid during the quarter, the excess credit may be carried over to the succeeding quarter and treated as a payroll tax credit for that succeeding quarter.

A payroll tax credit claimed on Form 941 will not be processed and given effect unless the taxpayer files Form 8974 with the Form 941. If the employer does not file Form 8974 with its employment tax return, but made deposits reflecting the payroll tax credit, it may be subject to failure-to-deposit penalty (unless it can show reasonable cause).

The Memorandum provides a 4-step process:

1.     Calculate the employer’s share of social security tax included in the liability to be reported on Form 941, line 16 (monthly depositors), or schedule B (semi-weekly depositors) for the first date wages are paid for the quarter.

2.     Compare that amount of employer social security tax to the amount of payroll tax credit available for the quarter.

a.     If the credit is greater than or equal to the employer’s portion of social security tax for that pay date, the employer’s portion is not reflected on Form 941, line 16, or Schedule B (as applicable) related to that first pay date and is not required to be deposited.

b.    If the credit is less than the employer’s portion of social security tax for that period, the employer’s portion of social security tax is reduced by the amount of the credit and the balance must be included on Form 941, line 16 or Schedule B (as applicable), and in the deposit related to that pay date.

3.     Timely deposit (a) the amount of employer social security tax that cannot be offset by the payroll tax credit, (b) the amount of employee social security tax, (c) the amount of employee and employer Medicare tax, and (d) the amount of income tax withholding.

4.     If employer portion of social security tax for the first pay date is less than the amount of the payroll tax credit allowed to be deducted for the quarter (or year if filing an annual employment tax return), the remaining payroll tax credit can be carried forward to offset the employer portion of social security tax in in subsequent pay dates in the return period applying these 4 steps until it is used up.

Q2. If a qualified small business files its tax return without electing the payroll tax credit, and later files an amended tax return electing the payroll tax credit, when can the taxpayer claim the payroll tax credit on its employment tax return?

A2. The taxpayer may claim the payroll tax credit on its employment tax return for the quarter beginning after the date the qualified small business filed the amended tax return.

Conclusion

IRS guidance provides that a qualified small business that timely filed its return for a taxable year beginning after Dec. 31, 2015, but failed to make the payroll tax credit election, can make the election on an amended tax return filed on or before Dec. 31, 2017*. To qualify for the extension, the business must either: 1) include ”FILED PURSUANT TO NOTICE 2017-23” at the top of the Form 6765 reflecting the payroll tax election, or 2) attach a statement to its Form 6765 that the form is filed pursuant to Notice 2017-23.

*Note: An example included in the Memorandum states that an amended return filed on Jan. 2, 2018 will be considered timely because Dec. 31, 2017 falls on a weekend and Jan. 1, 2018 is a legal holiday.

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