The Protecting Americans from Tax Hikes (PATH) Act of 2015 makes permanent the research and development (R&D) tax credit, which had expired for amounts paid or incurred after December 31, 2014. In addition, the PATH Act gives certain small businesses the option to claim the R&D tax credit as a reduction to the Social Security portion (the employers’ share) of their FICA tax liability.
The R&D tax credit is one of 35 other types of credits (e.g., investment tax credit, work opportunity credit, low-income housing credit) that compose the general business credit. For a taxable year, a taxpayer claims the general business tax credit as a credit against its income tax liability. If the general business tax credit exceeds the taxpayer’s income tax liability for the taxable year, the taxpayer can carry the excess credit forward to the next taxable year.
Under the new provision, for taxable years beginning after December 31, 2015, a qualified small business may elect for any taxable year to claim a certain amount of its R&D tax credit as a credit against its share of the old age, survivors and disability insurance (OASDI) portion (often referred to as the “Social Security” portion) of the FICA tax. Once made, the election cannot be revoked without IRS consent.
A qualified small business is defined, with respect to any taxable year, as a corporation (including an S corporation) or partnership (1) with gross receipts of less than $5 million for the taxable year, and (2) that did not have gross receipts for any taxable year before the five-taxable-year period ending before the taxable year (generally, a relatively new business). For example, for the 2016 taxable year, the corporation or partnership could not have any gross receipts before the 2011 taxable year (i.e., 2015, 2014, 2013, 2012 and 2011 would be the five-taxable-year period ending before 2016). A sole proprietorship meeting these requirements will be considered a qualified small business, but a tax-exempt organization will not.
The amount of the R&D tax credit that can be applied against the qualified small business’ share of the OASDI portion of the FICA tax is limited to the least of:
- the amount specified by the taxpayer that does not exceed $250,000;
- the R&D tax credit determined for the taxable year; and
- for a qualified small business other than a partnership or S corporation, the amount of the general business credit carryforward from the taxable year.
A qualified small business annually may elect the specified amount of the R&D tax credit, not to exceed $250,000, to be applied as a credit against its share of the OASDI portion of the FICA tax. A qualified small business is limited in the number of taxable years for which it can make an election. The new provision provides that a qualified small business may not make an election if it “has made an election … for 5 or more preceding taxable years.”
A qualified small business cannot claim the R&D tax credit against the FICA tax until it files its income tax return for the taxable year. Specifically, it can claim the credit for the first calendar quarter beginning after the date on which it files its income tax return. For example, if a qualified small business that is a corporation files its 2016 Form 1120 on March 15, 2017, it can claim the R&D tax credit on its 2017 second quarter Form 941. If the R&D tax credit exceeds the qualified small business’ share of the OASDI portion of the FICA tax, the excess is allowed as a credit against the OASDI liability for the following calendar quarter.
IRS has experience with adjustments to the employer’s share of the FICA tax for taxpayer incentives. Under the Hiring Incentives to Restore Employment (HIRE) Act, which was enacted in 2010, employers hiring unemployed workers were essentially exempted from paying their share of the OASDI portion of FICA taxes. See HIRE Act Provides Tax Breaks for Hiring Unemployed Workers. As with the HIRE Act, IRS will likely need to modify Form 941.
Each qualified small business will need to determine whether claiming the R&D tax credit against the FICA tax is better than claiming it against income tax. Certainly, for those qualified small businesses with no taxable income, claiming the R&D tax credit against the FICA tax will provide an immediate economic benefit.