The IRS has issued an August 7, 2023 draft version of Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, with a December 2023 revision date.
Background.
Code Sec. 41, “Credit for Increasing Research Activities,” allows taxpayers a credit against income tax for increasing research activities. Generally, the research credit is equal to the sum of 20% of the excess (if any) of the taxpayer’s qualified research expenses (“QREs”) for the taxable year over the base amount.
Taxpayers may elect to determine their credit under the alternative simplified credit (ASC) rules of Code Sec. 41(c)(4), where the credit is equal to 14% of the QREs for the taxable year over 50% of the average QREs for the three taxable years preceding the credit year.
The research credit is calculated on Form 6765, Credit for Increasing Research Activities, and is generally applied against a taxpayer’s income tax liability.
Payroll tax credit.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 enacted Code Sec. 41(h) and Code Sec. 3111(f), which allow a qualified small business (“QSB”) to elect to apply a portion of the research credit for the taxable year as a payroll tax credit against the employer portion of the old-age, survivors, and disability insurance tax (“Social Security tax”) under the Federal Insurance Contributions Act (FICA).
This election is designed to benefit an eligible startup that has little or no income tax liability. The payroll tax credit is elected by completing the appropriate portion of Form 6765 and attaching the completed form to the QSB’s timely filed (including extensions) income tax return for the taxable year to which the election applies. An election cannot be made with an amended return.
Form for determining the payroll research tax credit.
The QSB can first claim the payroll tax credit on its employment tax return for the first quarter that begins after it files the income tax return reflecting the payroll tax election on Form 6765. A QSB claiming the payroll tax credit on its employment tax return must complete Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, and attach the completed form to the employment tax return (i.e., Form 941, Employer’s Quarterly Federal Tax Return).
Amount of credit prior to 2023.
For taxable years beginning after December 31, 2015, and before January 1, 2023, the maximum research credit that could be elected in a tax year to be applied toward payroll taxes was $250,000. The credit could be applied against the employer’s share of Social Security tax, as imposed by Code Sec. 3111(a), beginning with the first quarter that begins after the timely filing of the return on which the election was made.
For employment tax returns covering taxable years beginning before January 1, 2023, the taxpayer may not use the payroll tax credit as a credit against any other employment tax liability and the credit may not be refunded in the absence of liability for the employer’s portion of Social Security tax.
Credit increase.
Provision 13902 of the Inflation Reduction Act of 2022 increased the maximum amount of payroll tax research credit that a QSB can elect to apply against payroll tax liability from $250,000 to $500,000 for tax years beginning after December 31, 2022.
Therefore, starting in the first quarter of 2023, the payroll tax credit is first used to reduce the employer’s share of Social Security tax up to $250,000 per quarter and any remaining credit reduces the employer’s share of Medicare tax for the quarter. Any remaining credit, after reducing the employer’s share of Social Security tax and the employer’s share of Medicare tax, is then carried forward to the next quarter. Form 8974 is used to determine the amount of the payroll tax credit that can be used in the current quarter.
Changes to the Form 8974 draft.
The August 7, 2023 draft version of Form 8974 no longer includes the following employment tax returns because these forms will no longer be available after the fourth quarter of 2023: Form 941-SS, Employer’s Quarterly Federal Tax Return—American Samoa, Guam, the Commonwealth of the Northern Mariana Islands, and the U.S. Virgin Islands, and Form 941-PR, Planilla para la Declaración Federal TRIMESTRAL del Patrono (see IRS Updates Substitute Form 941, Schedules, and 8974 Specifications, 03/27/2023).
Instead, employers in the U.S. territories will file Form 941 or the new Spanish version of this form. All references to these two forms have been removed from the August 7, 2023 draft version of Form 8974.
Comments on the draft forms.
Comments on draft forms may be sent to the IRS at IRS.gov/FormsComments. Those submitting comments should include “NTF” followed by the form or pub number (for example, “NTF8974) in the body of the message to route the message properly.
See Payroll Guide ¶4277 for more information on business tax credits.
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