Startups with qualifying research expenses have for the first time an additional option whereby they can choose to apply up to $250,000 of its research credit against its payroll tax liability. This new option is available to any eligible small business filing its 2016 federal income tax return this tax season.

If, somehow, such a small business failed to choose this option while filing their 2016 Tax return, and still wishes to do so, it can still make the election by filing an amended return by Dec. 31, 2017. This new option was introduced through the PATH Act enacted in 2015.

The option to elect the new payroll tax credit is especially beneficial for any eligible startup that has little or no income tax liability.

Key provisions of this new option are:

• To qualify for the new option for the current tax-year, a business must have gross receipts of less than $5 million and must not have had gross receipts prior to 2012.
• Such businesses can chose to apply upto $250,000 of its Research credit against the employer portion of Social Security Tax (FICA) for any calendar quarter.
• Any amount of the payroll tax credit that exceeds the limitation for any calendar quarter could be carried to the succeeding calendar quarter and allowed as a payroll tax credit for such quarter.
• Tax exempt organizations (Sec 501 entities) are not eligible for this benefit as they as are not qualified small businesses for the purpose.
• The aggregate gross receipts of all members of a controlled group for a taxable year must be taken into account in determining whether the Gross Receipt rules of this notice are satisfied or not.
• This payroll tax credit election cannot be made by taxpayer who has made such an election for 5 or more preceding taxable years.

To take advantage of this option, the qualified small business makes a payroll tax credit election in Form 6765 – Credit for Increasing Research Activities, in the portion relating to the payroll tax credit election, and attaching it to its timely filed (including extension) Tax return for the taxable year to which the election applies.

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 Tax credit election. This is done by filing Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, and attaching the completed form to that employment tax return.

IRS Notice 2017-23 providing Interim guidance regarding this option is available here.