IRS Provides Interim Guidance for Claiming Payroll Tax Credit for Research Activities

The Treasury and the IRS recently released Notice 2017-23 providing interim guidance related to  the payroll tax credit for research expenditures by qualified small businesses under Code § 3111(f).  (See prior coverage.)  Specifically, the notice provides interim guidance on the time and manner of making the payroll tax credit election and claiming the credit, and on the definitions of “qualified small business” and “gross receipts.”  Comments are requested by July 17, 2017.

Code § 41(a) provides a research tax credit against federal income taxes.  Effective for tax years beginning after December 31, 2015, Code §§ 41(h) and 3111(f) allow a “qualified small business” to elect to apply a portion of the § 41(a) research credit against the employer portion of the social security tax under the Federal Insurance Contributions Act.  Generally, a corporation, partnership, or individual is a qualified small business if its “gross receipts” are less than $5 million and the entity did not have gross receipts more than 5 years ago.  The election must be made on or before the due date of the tax return for the taxable year (e.g., Form 1065 for a partnership, or Form 1120-S for an S corporation).  The amount elected shall not exceed $250,000, and each quarter, the amount that the employer may claim is capped by the employer portion of the social security tax imposed for that calendar quarter.

The notice provides that, to make a payroll tax credit election, a qualified small business must attach a completed Form 6765 to its timely filed (including extensions) return for the taxable year to which the election applies.  The notice provides interim relief for qualified small businesses that timely filed returns for taxable years on or after December 31, 2015, but failed to make the payroll tax credit election.  In this case, the entity may make the election on an amended return filed on or before December 31, 2017.  To do so, the business must either: (1) indicate on the top of its Form 6765 that the form is “FILED PURSUANT TO NOTICE 2017-23”; or (2) attach a statement to this effect to the Form 6765.

A qualified small business can claim the payroll tax credit on its Form 941 for the first calendar quarter beginning after it makes the election by filing the Form 6765.  Similarly, if the qualified small business files annual employment tax returns, it may claim the credit for the return that includes the first quarter beginning after the date on which the business files the election.  A qualified small business claiming the credit must attach a completed Form 8974 to the employment tax return.  On the Form 8974, the taxpayer filing the employment tax return claiming the credit provides the Employer Identification Number (EIN) used on the Form 6765.

For qualified small businesses filing quarterly employment tax returns, they must use the Form 8974 to apply the social security tax limit to the amount of the payroll tax credit it elected on Form 6765 and to determine the amount of the credit allowed on its quarterly employment tax return.  If the payroll tax credit elected exceeds the employer portion of the social security tax for that quarter, then the excess determined on the Form 8974 is carried over to the succeeding calendar quarter(s), subject to applicable social security tax limitation(s).

The notice also provides guidance for purposes of defining a “qualified small business.”  Specifically, the notice provides that the term “gross receipts” is determined under Code § 448(c)(3) (without regard to Code § 448(c)(3)(A)) and Treas. Reg. § 1.448-1T(f)(2)(iii) and (iv)), rather than Code § 41(c)(7) and Treas. Reg. § 1.41-3(c).  Therefore, gross receipts for purposes of the notice do not, as Treas. Reg. § 1.41- 3(c) does, exclude amounts representing returns or allowances, receipts from the sale or exchange of capital assets under Code § 1221, repayments of loans or similar instruments, returns from a sale or exchange not in the ordinary course of business, and certain other amounts.

IRS Provides Guidance on De Minimis Safe Harbor for Errors in Amounts on Information Returns

The IRS today released Notice 2017-09 providing guidance on the de minimis safe harbor for errors in amounts reported on information returns.  The safe harbor was added to Sections 6721 and 6722 by the Protecting Americans from Tax Hikes Act of 2015 (PATH Act).

Under the statute, filers are not subject to penalties under either Section 6721 and 6722 if an amount reported on the return is within $100 of correct amount or within $25 if the amount is an amount of tax withheld.  However, if the payee requests a corrected return, the filer must file and furnish one or the payee is liable for potential penalties.  Prior to the enactment of the PATH Act, any error in an amount was considered consequential and could result in a penalty—even if the error was only one cent.  With this change, de minimis errors no longer necessitate corrected information returns or payee statements.  The safe harbor is effective for information returns and payee statements required to be filed after December 31, 2016.

Notice 2017-09 specifies that the safe harbor will not apply in the event of an intentional error or if a payor fails to file a required information return or furnish a required payee statement.  In other words, a filer cannot use the safe harbor to increase the filing threshold for reporting by arguing that the amount that should have been reported was within $25 of a threshold.  Accordingly, if a filer determines that a Form 1099-MISC was not required because the amount paid to the payee was $550 and later determines the amount paid was actually $650, the safe harbor would not apply.  Similarly, filers cannot apply the safe harbor to avoid penalties for payees of interest of less than $100 for whom they did not file a Form 1099-INT because the filer incorrectly believed the interest paid was less than $10.

The notice also clarifies the process by which a payee may request a corrected information return by electing that the safe harbor not apply.  If the payee makes such an election and the payor furnishes a corrected payee statement and files a corrected information return within 30 days of the election, the error will be deemed to be due to reasonable cause and neither Section 6721 or 6722 penalties shall apply unless specific rules specify a time in which to provide the corrected payee statements, such as for Forms W-2.  The notice leaves unanswered, however, how this rule will apply when a payee has an ongoing election not to apply the safe harbor in effect as described below.

The notice permits payors to prescribe any reasonable manner for making the election, including in writing, on-line, or by telephone, provided that the payor provide written notification of the manner prescribed before the date the payee makes an election.  If on-line elections are prescribed by the payor, the payor must also provide another means for making an election.  If the payor has prescribed a manner for making such an election, the payee must make the election using the prescribed manner and elections made otherwise are not valid.  If the payor has not prescribed a manner for making the election, the payor may make an election in writing to the payor’s address on the payee statement or by a manner directed by payor after making an inquiry.  The payor may not otherwise limit the payee’s ability to make the election.

Payees are permitted to make an election with respect to information returns and payee statements that were required to be furnished in the calendar year of the election.  Alternatively, a payee may make an election for such returns and payee statements and all succeeding calendar years.  The statute did not clearly envision an ongoing election as prescribed in the notice.  The decision to allow for an ongoing election as opposed to an annual election requirement raises compliance concerns with respect to small payors who do not have electronic vendor management systems and with respect to payees who only receive intermittent payments that may have been inactivated in the payor’s systems.

The payee may subsequently revoke an election at any time after the election is made by providing written notice to the payor.  The revocation applies to all information returns and payee statements of the type specified in the revocation that are required to be filed and furnished, respectively, after the date on which the payor receives the revocation.

A valid election must: (1) clearly state that the payee is making the election; (2) provide the payee’s name, address, and taxpayer identification number (TIN); (3) identify the type of payee statement(s) and account number(s), if applicable, to which the election applies if the payee wants the election to apply only to specific statements; and (4) if the payee wants the election to apply only to the year for which the payee makes the election, state that the election applies only to payee statements required to be furnished in that calendar year.  If the payee does not identify the type of payee statement and account number or (ii) the calendar year to which the election relates, the payor must treat the election as applying to all types of payee statements that the payor is required to furnish to the payee and as applying to payee statements that are required to be furnished in the calendar year in which the payee makes the election and all succeeding calendar years.

The notice indicates that it does not prohibit a payee from making a request with respect to payee statements required to be furnished in an earlier calendar year.  It is not clear, however, whether such a request must be honored by the payor.

With respect to Forms W-2, Notice 2017-09 encourages employers to correct any errors on Forms W-2c even though the safe harbor may apply.  The notice expresses concern that failure to correct de minimis errors on Forms W-2 will result in combined annual wage reporting (CAWR) errors.  Under the CAWR program, the IRS compares amounts reported on Forms 941 with those reported on Forms W-3 and the processed totals from Forms W-2.  When the amounts do not match, an intentional disregard penalty is automatically assessed under Section 6721.  Although the notice does not specify as much, these penalties would presumably be abated if the employer demonstrated that the mismatch resulted from de minimis errors that were not required to be corrected under the safe harbor.

The notice states that the Treasury Department and IRS intend to issue regulations incorporating the rules contained in the notice.  The regulations are also expected to require payors to notify payees of the safe harbor and the option to make an election to have the safe harbor not apply.  The notice also indicates that the regulations may provide that the safe harbor does not apply to certain information returns and payee statements to prevent abuse as permitted by the statute, but does not indicate which, if any, information returns the IRS believes raise such concerns.  Comments are requested on the rules in the notice and are due by April 24, 2017.

IRS Releases New Form on Which Small Businesses Should Claim Payroll Tax Credit for R&D Expenditures

The IRS released draft Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, which qualified small business (i.e., start-up businesses) will use to claim the new payroll tax credit available to start-up businesses for qualified research and development (R&D) expenses up to $250,000.  As we explained in a prior post, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) allowed start-up businesses to take advantage of the R&D tax credit by allowing them to offset the employer portion of the Social Security tax—the credit was previously only available to companies that could offset such expenditures against taxable income.  Also covered in that post were modifications to two existing forms to accommodate the reporting of the expanded R&D tax credit: Form 6765, Credit for Increasing Research Activities, and Form 941, Employer’s Quarterly Federal Tax Return.

The new form allows qualified small businesses to calculate the amount of the qualified small business payroll tax credit for the current quarter. Taxpayers will file Form 8974 quarterly by attaching it to Form 941.  Form 8974 calculates the amount of payroll tax credit available to the taxpayer based on Line 44 of the prior tax year’s Form 6765, and the amount of social security taxes reported for the quarter, which is pulled from Column 2 of Lines 5a and 5b of the Form 941 on which the credit is applied.  The amount reported on Line 12 of Form 8974 is the payroll tax credit that qualified small businesses should report on Line 11 of the Form 941 (generally, the amount of the total credit allowable based on the prior year’s Form 6765 or 50% of the reported Social Security tax reported on the Form 941 for the current quarter).

Notice 2016-48 Implements PATH Act’s ITIN Changes, Clarifies Application of New Rules to Information Returns

The IRS recently issued Notice 2016-48 to implement changes to the individual tax identification number (ITIN) program that had been adopted by Congress.  The notice explains the changes made to the ITIN program, as well as how the IRS plans to implement those changes, and the consequences to taxpayers who do not comply with the new rules.

ITINs are issued to taxpayers who are required to have a U.S. taxpayer identification number but who are not eligible to obtain a social security number.  As discussed in an earlier post, the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), signed into law in December 2015, made it more difficult for nonresident aliens to maintain valid ITINs by amending Section 6109 of the Internal Revenue Code, the provision that permits the IRS to issue taxpayer identification numbers and request information to issue such numbers.  Specifically, under the PATH Act, Treasury must move toward an in-person ITIN application process, ITINs must be renewed to avoid expiration, and ITINs must be used to file a U.S. tax return to avoid expiration.

Application Procedures.  Under the current application procedures, taxpayers may apply for an ITIN by submitting Form W-7, Application for IRS Individual Taxpayer Identification Number by mail or in-person.  Notice 2016-48 does not execute Congress’s directive to establish an exclusively in-person application program, instead continuing the current application procedures, while the IRS takes additional time to determine how to implement the PATH Act’s mandate.  The IRS announced that further guidance will be issued.

ITIN Expiration.  The PATH Act made ITINs no longer indefinitely valid.  Any ITIN that is not used on a federal tax return for three consecutive years will expire on December 31 of the third year.  Taxpayers with an ITIN that has expired because they have not used it in three consecutive years may renew the ITIN any time after October 1, 2016 by submitting Form W-7 and the required accompanying documentation.

The PATH Act sets forth a schedule by which ITINs issued before 2013 will expire.  That schedule, which is based upon the issue date of the ITIN, was modified by Notice 2016-48 because many individuals do not know when their ITINs were issued, making the PATH Act’s schedule impractical.  Under Notice 2016-48, ITINs will expire under a multi-year schedule based upon the fourth and fifth digits of the ITIN.  Under this renewal system, ITINs with the middle digits 78 or 79 will expire on January 1, 2017, and future guidance will set forth the expiration schedule for other middle digit combinations.  The IRS will send Letter 5821 to individuals who used an ITIN with the middle digits 78 or 79 on a U.S. income tax return in any of the previous three years, notifying them of the upcoming expiration.

The IRS will accept returns with expired ITINs, but it warns taxpayers that processing delays may result and certain credits may not be allowed.  The processing delays and unavailability of certain credits could result in additional penalties and interest and a reduced refund.

Information Returns.  Expired ITINs are permitted to be used on information returns, meaning that holders of expired ITINs that are only used on returns filed by third parties, such as the Form 1099 or Form 1042 series, are not required to renew their ITINs.  Filers of information returns are not subject to penalties under Section 6721 or 6722 for the use of an expired ITIN on information returns. (However, many individuals who receive such information returns are required to file U.S. income tax returns necessitating that they renew their ITINs.)

IRS Releases Drafts of Forms 941 and 6765 to Enable R&D Payroll Tax Credit Under Section 3111(f)

The IRS released drafts of Form 941 and Form 6765 to facilitate a new payroll tax credit intended to allow start-up businesses to take advantage of the research and development (R&D) credit in Section 41 of the Internal Revenue Code.  In the past, start-up businesses took issue with the R&D tax credit because the credit was an income tax credit.  Because start-up businesses may not have taxable income for several years, they were not able to take advantage of the credit.

The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) expanded the R&D credit by adding new Sections 41(h) and 3111(f) to the Code.  Those sections allow “qualified small businesses” to elect to claim the credit (up to a maximum of $250,000) as a payroll tax credit. Those employers may elect to use the credit to offset the employer portion of Social Security tax.  It may not be used to reduce the amount of Social Security tax withheld from employees’ wages, nor may it be used to offset the employer or employee share of Medicare tax.  For purposes of the credit, a “qualified small business” is an employer with gross receipts of less than $5 million in the current taxable year and no more than five taxable years with gross receipts.  Qualified small businesses may claim the R&D payroll tax credit in tax years beginning after December 31, 2015.

The IRS added two lines to Form 941 (Employer’s Quarterly Federal Tax Return). Qualified small businesses will report the amount of the credit on Line 11 and report the total applicable taxes after adjustments and credits on Line 12.  In addition, qualified small businesses will elect to take a portion of the R&D credit as a payroll tax credit by completing new Section D on Form 6765 (Credit for Increasing Research Activities).  Comments on the forms can be submitted on the IRS web site.

The IRS subsequently released a draft Form 8974 that is used to calculate the payroll tax credit.

IRS Proposed Regulations Clarify College Tuition Reporting Requirements Following TPEA and PATH Act

The IRS released proposed regulations on July 29 to reflect changes made to the Form 1098-T reporting requirements by Congress as part of the Trade Preferences Extension Act of 2015 (TPEA) and the Protecting Americans from Tax Hikes Act of 2015 (PATH Act).  The proposed regulations were issued in response to requests for additional guidance made by college financial officers and industry analysts.  The proposed regulations were published in the Federal Register today, and they will become effective on the date that final regulations are published.

Penalty Relief.  The proposed regulations amend the regulations under Section 6050S of the Internal Revenue Code to reflect new Section 6724(f) of the Code.  That provision was added by the TPEA and prohibits the IRS from imposing information reporting penalties under Sections 6721 and 6722 on educational institutions for failing to include a correct TIN on Form 1098-T if the educational institution certifies under penalty of perjury that it complies with the IRS’s rules governing TIN solicitations.  The applicable TIN solicitation rules are the same as under the existing regulations.  In general, if the educational institution does not have a record of the individual’s correct TIN, it must solicit the TIN on or before December 31 of each year during which it receives payments of qualified tuition and related expenses or makes reimbursements, refunds, or reductions of such amounts with respect to the individual.  If the individual does not provide his or her TIN upon request, the institution must file Form 1098-T without the TIN but with all other required information.

Reporting Exceptions.  The TPEA amended Section 25A of the Code so that a taxpayer may only claim an education credit if it receives a Form 1098-T from the educational institution that includes all of the required information, including the taxpayer’s TIN.  The proposed regulations amend the existing regulations under Section 6050S of the Code to eliminate a number of exceptions to the Form 1098-T reporting requirement that the IRS determined would frustrate the purpose of TPEA by depriving students of the Form 1098-T required to claim an education credit for which they may otherwise be eligible.  The current regulations under Section 6050S provide four exceptions to the Form 1098-T reporting requirement: (i) nonresident aliens, except upon request by the nonresident alien; (ii) individuals whose qualified tuition and related expenses are paid entirely with scholarships; (iii) individuals whose qualified tuition and related expenses are paid under a formal billing arrangement; and (iv) information with respect to courses for which no academic credit is awarded.  The proposed regulations maintain the exception related to courses for which no academic credit is awarded but eliminate the other three reporting exceptions.

New Reporting Requirement.  Additionally, the proposed regulations require educational institutions to report the number of months that a student was a full-time student during the calendar year on Form 1098-T.  The change is intended to help the IRS determine whether a parent properly claimed the student as a dependent, and therefore, properly claimed the credit for the student’s educational expenses.  For this purpose, one day during a month is treated as an entire month.

Amounts Reported.  In addition, the PATH Act requires educational institutions to report the amount of payments actually received for qualified tuition and related expenses on Form 1098-T, rather than simply the amount of payments billed.  This requirement is carried through to the proposed regulations, subject to the transition relief announced in IRS Announcement 2016-17 that allows educational institutions to report the amount billed for 2016, as explained in our earlier article.

To determine the amount of payments received for qualified tuition and related expenses, the proposed regulations instruct educational institutions to treat payments received during a calendar year as payments received for qualified tuition and related expenses up to the amount billed for such expenses, and any amount in excess of the amount billed as payments for other expenses.

New ITIN Requirements in PATH Act Pose Challenges for Taxpayers and IRS

The PATH Act, signed into law in December 2015, may cause trouble for nonresident aliens who use individual tax identification numbers (ITINs) to file U.S. tax returns, as it creates additional hurdles to maintain a valid ITIN.  First, ITINs granted before 2013 must be renewed between 2017 and 2020 pursuant to a staggered schedule or they will expire.  Second, if an individual fails to file a U.S. tax return for three years, their ITIN will expire.  Third, the Treasury must adopt a system that will require in-person ITIN applications.

The new requirements are part of Congress’s attempts to reform certain IRS programs in order to improve their reliability, but it will likely inconvenience many taxpayers seeking to acquire ITINs.  Nonresident alien individuals need to obtain an ITIN to complete a Form 8233 asserting treaty relief from withholding on personal services income.  The process is already a difficult one for many nonresident alien taxpayers due to various procedural hurdles—such as obtaining a written denial letter from the Social Security Administration—that already existed.  Moreover, many nonresident aliens whose income is exempt from U.S. tax under a treaty do not file a Form 1040-NR and attach Form 8833 as required.  The changes in the PATH Act may force them to meet this filing requirement.

The result of the changes will increase the volume of applicants, since many will need to be renewed in the coming years.  Speaking at the recent American Bar Association Section of Taxation meeting in Washington, D.C., Julie Hanlon-Bolton, a representative from the IRS Wage and Investment Division, stated that the IRS is currently debating whether the ITIN offices will require additional staffing, and whether new or expanded offices may be needed in Austin, Texas.  This would require employing additional certified acceptance agents.  A certified acceptance agent is someone who has been trained to verify the authenticity of identification documents and trained in the process for a person to apply for an ITIN.

IRS Provides Transitional Relief for PATH Act’s Changes to Form 1098-T Reporting for Colleges and Universities

April 28, 2016 by  
Filed under Information Reporting, IRS

On April 27, 2016, the IRS issued transitional penalty relief to colleges and universities under Announcement 2016-17 with respect to new reporting requirements implemented as part of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act). Prior to the PATH Act, eligible educational institutions were required to report annually on Form 1098-T either (i) the aggregate amount of payments received for qualified tuition and related expenses, or (ii) the aggregate amount billed for such tuition and expenses. Section 212 of the PATH Act eliminates the option to report payments billed, meaning that colleges and universities must report the amount of payments received each year on a prospective basis.

If a college or university fails to properly file correct or timely tuition information with the IRS or furnish a proper written statement to the recipient, reporting penalties will apply under sections 6721 and 6722. Numerous eligible educational institutions notified the IRS that the law change would require computer software reprogramming that could not be completed prior to the 2016 deadlines for furnishing Forms 1098-T, which would trigger widespread penalties. Accordingly, Announcement 2016-17 permits eligible educational institutions to report the aggregate amount billed on all 2016 Forms 1098-T, effectively providing one year of transitional relief.