In December 2015, the "Protecting Americans from Tax Hikes Act of 2015" (the 2015 PATH Act) was enacted and contains a provision making permanent the popular research tax credit (R&D).
The credit (1) is for 20% of current year qualified research expenses that exceeds a base amount related to gross receipts in certain earlier years, and (2) can't exceed 10% of the qualified research expenses in the current year. Alternatively, taxpayers can irrevocably choose a simpler calculation.
The PATH Act also make two major changes to the tax credit, both favorable to small businesses. First, it provides that beginning in 2016 eligible small businesses (ESB) may claim the credit against their alternative minimum tax (AMT) liability. An ESB is a business with less than $50 million in average gross receipts for the three preceding tax years.
Second, beginning in 2016, the new law provides that the credit can be used by qualified small businesses (QSB) against the Social Security portion of the employer's payroll tax (i.e., FICA) liability. A QSB is generally defined as a business with gross receipts of less than $5 million, and no gross receipts before the previous five tax year periods ending with the current year.
The research credit is one of the credits that comprise the general business credit (GBC). The GBC is limited to net income tax. The unused portion of the credit can be carried back one year and forward 20 years.
In the original legislation, an early stage company that incurred qualified research expenses could not collect the R&D credit if the company used a professional employer organization (PEO), since it did not have any FICA tax liability to offset with the credit.
The Internal Revenue Service (IRS) has made a clarification in determining the amount of the R&D tax credit; the Company takes into account wages and federal employment taxes paid by the CPEO. The IRS maintains a list of CPEOs and also a list of CPEOs that have been suspended or revoked. https://www.irs.gov/for-tax-pros/basic-tools/cpeo-public-listings
The Process to Collect the R&D Tax Credit
The election to use a portion of the research tax credit against the employer's share of social security tax is made on the Form 6765, Credit for Increasing Research Activities, filed by the customer with their income tax return.
The credit is claimed on the Form 941 filed for the first calendar quarter that begins after the QSB's federal income tax return is filed for the tax year in which the election is made on Form 6765. For example, a calendar-year taxpayer that files its 2016 federal income tax return on April 17, 2017, claims the 2016 QSB payroll tax credit portion of the Section 41 research credit on its 2017 third quarter Form 941, which is filed by October 31, 2017.
The tax credit must be claimed on the Form 941 filed for the first calendar quarter that begins after the QSB's federal income tax return for the prior tax year is filed. It cannot be claimed on a different quarter's Form 941. However, the credit can be carried over to the subsequent quarter if the entire credit amount cannot be used on the Form 941 on which the credit amount is claimed.
The amount of tax credit applied as a payroll tax credit is computed on form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. The amount computed on the Form 8974 is the amount of research credit that can be used in the current period (i.e., quarter. The amount from the Form 8974, line 12, is reported on Form 941 Line 11. If a taxpayer is claiming the research payroll tax credit on its Form 941, it must attach a Form 8974 to the Form 941.
For purposes of federal employment taxes and other obligations under the federal employment tax rules, a CPEO is generally treated as the employer of any individual performing services for a customer of the CPEO and for remuneration remitted to the individual by the CPEO.
The IRS has issued an updated version of Form 941, Schedule R, Allocation Schedule for Aggregate Form 941 Filers, indicating that it must be filed by CPEOs and that filers of the schedule must provide information on the schedule if they use a portion of their research tax credit as a payroll tax credit. The CPEO must file Form 941, Schedule R, in addition to Forms 8974 and 941. The IRS will permit a CPEO to claim a research tax credit on behalf of its customers. The customer and the CPEO will contractually arrange to have the tax savings to the CPEO passed through to the customer through reduced fees.
You are no longer required to fire your PEO to collect the R&D tax credit. You just need to make sure your PEO is an IRS-certified PEO (CPEO). Please contact us if we can help.
For NC-based entrepreneurs looking for seedfunding, the fall cycle for NC IDEA's $50,000 Seed Grant applications is openAugust 28th
through 5:00 pm on September 11th
. This isa great source of non-dilutive early stage funding for those early stageinnovative startup companies who are between proof of concept and profitability. Learn more here. http://ncidea.org/grants-programs/seed-grant/
I look forward to seeing you at the CED Tech Venture Conference in September. https://cednc.org/TVC Don't forget to register by August 24th to get early bird pricing.
Brooks Malone, Partner
Technology Practice Leader
Hughes Pittman & Gupton, LLP