According to a December 19, 2018 Treasury Inspector General for Tax Administration (TIGTA) report, the IRS does not currently have processes in place to identify small businesses that do not meet the eligibility requirements and dollar limitations for claiming the startup payroll tax offset created in the 2015 PATH Act legislation. TIGTA conducted a review of 1,467 startup R&D credit claims for tax year 2017 and found 143 claims that potentially fell outside the PATH act startup guidelines. Questions with these claims centered largely on eligibility requirements, while 55 taxpayers were flagged for claiming the payroll tax offset on a tax return prior to 2016. TIGTA’s takeaway from this potentially complex situation was simple, “Processes are needed to identify small businesses erroneously claiming the research tax credit payroll tax offset.”
The real takeaway from this page-turner of a report is that startups need to ensure correct classification with the PATH act startup definitions because compliance procedures are on the way. While the R&D tax credit has always presented complex issues in terms of technical qualification, this added layer of complexity for small businesses presents additional risk. As the IRS develops procedures to identify erroneous claims, the risk of improper classification as a “startup” is one small business can ill afford.
A qualified small business is defined as a corporation or partnership with both $5 million or less in gross receipts for the tax year and no gross receipts for any tax year before the five tax year period ending with the tax year for which the claim is made. The maximum amount that can be elected to offset payroll tax is $250,000 per credit year. The election is made on Form 6765 and reported on Form 8974 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities). Form 8974 is filed with the company’s quarterly payroll tax filing on form 941.