IRS offers a new way for small business startups to claim the research tax credit

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The Internal Revenue Service has issued a notice explaining how small businesses can take advantage of a new option allowing them to apply a portion or all of their research credit against their payroll tax liability, instead of their income tax liability.

Before 2016, taxpayers could only take the research credit against their income tax liability, but thanks to the PATH Act legislation passed at the end of 2015, they have a new option.

Notice 2017-23, posted Thursday on, provides interim guidance for eligible small businesses filing their 2016 federal income tax return this season. The IRS noted that businesses that have already filed this season still have time to opt for the new choice.

The option to elect the new payroll tax credit can particularly help business startups that have little or no income tax liability. To qualify for the new option this tax year, the business needs to have gross receipts of under $5 million and it can't have any gross receipts before 2012.

An eligible small business that has qualifying research expenses can decide to apply up to $250,000 of its research credit against its payroll tax liability. The business can choose this option by filling out Form 6765, Credit for Increasing Research Activities, and attach it to a business income tax return that has been filed on a timely basis. Under a special rule for tax year 2016, a small business that didn't originally choose this option, but now wants to do so, can still make the election by filing an amended return by Dec. 31, 2017.

After picking this option, a small business can claim the payroll tax credit by completing Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. Form 8974 form needs to be attached to a payroll tax return, such as Form 941, Employer’s Quarterly Federal Tax Return. The notice provides further details, along with interim guidance on controlled groups, the definition of gross receipts, and other issues.

The notice also asks for public comment on other payroll tax credit issues to be addressed in future guidance. For more information on the research credit itself, see the instructions for Form 6765.

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R&D credit Tax credits Tax regulations PATH Act Small business IRS