The Protecting Americans from Tax Hikes Act of 2015 provided for a new way for certain businesses to receive the benefit of the research credit under IRC §41.  A qualifying small business may, in lieu of the income tax credit, receive a credit against the employer portion of social security taxes [IRC §41(h)].  The IRS has provided interim guidance on taking advantage of this provision in Notice 2017-23.

A “qualifying small business” for this purpose must meet the following criteria:

• The gross receipts (as determined under the rules of § 448(c)(3), without regard to subparagraph (A) thereof) of such entity for the taxable year are less than $5,000,000, and
• Such entity did not have gross receipts (as so determined) for any taxable year preceding the 5-taxable-year period ending with such taxable year.

For an individual, the above limits are computed using only the aggregate gross receipts received by the person in carrying on the trades or businesses of the person.  As well, an organization exempt from tax under IRC §501 is not eligible to claim this payroll tax credit.

The credit is capped at $250,000 for any payroll tax election.

The IRS begins the Notice by stating:

The Treasury Department and the IRS recognize that businesses need immediate guidance to determine their eligibility for the payroll tax credit election with respect to taxable years beginning in 2016, and the procedures for making the election and claiming the credit.  In response to Notice 2016-26, 2016-14 I.R.B. 533, which requests recommendations for the 2016-2017 Priority Guidance Plan, several commenters requested guidance under §§ 41(h) and 3111(f).  In particular, commenters requested guidance regarding the term “gross receipts” for purposes of determining whether a business is a “qualified small business” under § 41(h)(3).  In addition, commenters requested guidance regarding controlled groups of corporations and groups of trades or businesses under common control (collectively referred to as controlled groups) in the context of § 41(h).  Because immediate guidance is necessary, this notice prescribes interim guidance in sections 3 and 4 regarding the definition of “qualified small business” and the time and manner of making the payroll tax credit election.  Further, because the Treasury Department and the IRS are developing guidance under § 41(h), the Treasury Department and the IRS request comments in section 6 of this notice on the interim guidance provided in this notice and other issues under § 41(h) that may require additional guidance.

The notice, while reciting the basic provisions of the law noted above for a qualifying taxpayer, provides the following specific examples of what is and what is not a qualified small business:

(1) Corp A, a calendar year corporation, is not a tax-exempt organization under § 501 or a member of a controlled group in taxable year 2016.  Corp A has gross receipts, as determined under section 3.04 of this notice, of $1 million, $7 million,$4 million, $3 million, and $4 million for taxable years 2012, 2013, 2014, 2015, and 2016, respectively.  Corp A did not have gross receipts, as determined under section 3.04 of this notice, for any taxable year prior to 2012.  Corp A is a qualified small business for taxable year 2016 because it has less than $5,000,000 in gross receipts for taxable year 2016 and did not have gross receipts before taxable year 2012 (before the-taxable-year period ending with 2016).  Corp A’s gross receipts in taxable years 2012-2015 are not relevant in determining whether Corp A is a qualified small business in taxable year 2016. Because Corp A had gross receipts in taxable year 2012, Corp A is not a qualified small business in taxable year 2017, regardless of its gross receipts in 2017.

(2) Corp A, Corp B, and Corp C are calendar year taxpayers that are not tax- exempt organizations under § 501 and are members of a controlled group for taxable year 2016 (Corp ABC controlled group).  Corp A has gross receipts, as determined under section 3.04 of this notice, of $1 million, $7 million, $4 million, $3 million, and $4 million for taxable years 2012, 2013, 2014, 2015, and 2016, respectively.  Corp B has gross receipts, as determined under section 3.04 of this notice, of $500,000, $1 million, $2 million, $1 million, and $1 million for taxable years 2012, 2013, 2014, 2015, and 2016, respectively.  Neither Corp A nor Corp B had gross receipts, as determined under section 3.04 of this notice, for any taxable year prior to 2012.  Corp C has gross receipts, as determined under section 3.04 of this notice, of $1 million, $3 million, $4 million, $3 million, $1 million, and $500,000 for taxable years 2011, 2012, 2013, 2014, 2015, and 2016, respectively.  Corp A, Corp B, and Corp C are not qualified small businesses for taxable year 2016 because the aggregate gross receipts of Corp ABC controlled group for taxable year 2016 are not less than $5 million ($4 million (Corp A) + $1 million (Corp B) + $500,000 (Corp C)).  In addition, neither Corp A, Corp B, nor Corp C is a qualified small business in taxable year 2016 because Corp C had gross receipts in taxable year 2011 (before the 5-taxable-year period ending with 2016).

The notice also outlines the following procedures for making the payroll tax credit election in Section 4.02:

A qualified small business makes a payroll tax credit election by completing the appropriate portion of Form 6765, Credit for Increasing Research Activities, or successor form, relating to the payroll tax credit election, and attaching the completed form to the qualified small business’s timely filed (including extensions) return for the taxable year to which the election applies.  The term “return” means the return required to be filed under § 6031 in the case of a partnership (for example, the Form 1065 or successor form), the return required to be filed under § 6037 in the case of an S corporation (for example, the Form 1120-S or successor form), and the return with respect to income tax for the taxable year in the case of any other qualified small business.

If a qualified small business timely files its return for a taxable year beginning after December 31, 2015, but fails to make the payroll tax credit election, it may make the election on an amended return filed on or before December 31, 2017. To qualify for this extension, the business must either: 1) indicate on the top of its Form 6765 reflecting the payroll tax credit election that the form is “FILED PURSUANT TO NOTICE 2017-23,” or 2) attach a statement to its Form 6765 reflecting the payroll tax credit election that the form is filed pursuant to Notice 2017-23.

The notice continues in Section 4.03 to outline the maximum amount of the election:

The amount of any payroll tax credit election may not exceed the least of:

(1) The qualified small business’s research credit for the taxable year (determined before the application of § 41(h)),

(2) $250,000, or

(3) In the case of a qualified small business other than a partnership or S corporation, the amount of the qualified small business’s business credit carryforward under § 39 carried from the taxable year (determined before the application of § 41(h)).

Notice Section 4.04 also provides that no election is available if the taxpayer has made an election for five or more preceding taxable years.

The notice contains, in Section 4.05, detailed provisions for dividing up the credit for members of a controlled group.

Section 4.06 details how to go about claiming the credit on payroll tax returns:

A qualified small business that elects to claim the payroll tax credit and files quarterly employment tax returns, claims the payroll tax credit on its employment tax return for the first quarter that begins after it files the return reflecting the election as specified in section 4.02 of this notice.  For example, if a qualified small business files an income tax return on April 10, 2017, with a Form 6765 attached reflecting the payroll tax credit election, the qualified small business would claim the payroll tax credit on its Form 941, Employer’s Quarterly Federal Tax Return, for the third quarter of 2017.  A qualified small business that files annual employment tax returns claims the payroll tax credit on its annual employment tax return that includes the first quarter beginning after the date on which the business files the return reflecting the election as specified in section 4.02 of this notice.  A qualified small business claiming the payroll tax credit on its employment tax return must complete Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, or successor form, and attach the completed form to that employment tax return.  Under various employment tax procedural rules, the Employer Identification Number (EIN) of the taxpayer filing the employment tax return may differ from the EIN of the taxpayer that filed the return with an attached Form 6765 reflecting the election as specified in section 4.02 of this notice. On Form 8974, the taxpayer filing the employment tax return claiming the credit provides the EIN used on the Form 6765 reflecting the election.

The payroll tax credit claimed by an employer on an employment tax return cannot exceed the employer portion of the social security tax for any calendar quarter on wages paid with respect to the employment of all individuals in the employ of the employer.  The employer uses Form 8974 to apply this limit to the amount of the payroll tax credit it elected on Form 6765 and to determine the amount of the credit allowed on its employment tax return.  If the payroll tax credit elected on Form 6765 exceeds this limitation, then the excess determined on Form 8974 is carried over to the succeeding calendar quarter(s) and allowed as a payroll tax credit for the succeeding quarter(s), subject to the social security tax limitation applicable to the quarter(s).

The notice concludes with a request for comments on issues to be dealt with in the permanent guidance to be issued later