AndreTaxCo, PLLC

Gross Receipts Limitations

To qualify for the payroll tax credit under IRC §41(h), a Qualified Small Business (QSB) must meet two key gross receipts requirements:

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1. Gross receipts for the credit year must be less than $5 million, and

2. The taxpayer must not have had gross receipts in any tax year before the five-tax-year period ending with the credit year.

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For example, to claim the payroll tax offset for the 2024 tax year, the taxpayer must have had less than $5 million in gross receipts in 2024 and must not have had any gross receipts in 2018 or earlier. However, a company that existed prior to 2019 but did not receive any gross receipts until 2019 or later may still qualify.

 

Although the law is designed to benefit small businesses, certain larger businesses—such as life sciences companies—may qualify if they have not yet generated gross receipts due to long development cycles (e.g., awaiting FDA approval).​

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For purposes of the gross receipts test, gross receipts are reduced by returns and allowances and must be annualized for short tax years, and predecessors are taken into account. For any person other than a corporation or partnership, only the aggregate gross receipts of the person in carrying on all of that person's trades or businesses are considered.

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Definition of Gross Receipts

Gross receipts are defined under IRC §448(c)(3) and Treas. Reg. §1.448-1T(f)(2)(iii)-(iv), and include:

• Total sales (net of returns and allowances)

• All amounts received for services

• Income from investments, including interest, dividends, rents, royalties, and annuities

• Incidental or outside income

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Gross receipts do not include:

• Repayment of loan principal

• Sales tax collected on behalf of a taxing authority (if legally imposed on the purchaser)

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Gross receipts must be annualized for short tax years, and predecessors are taken into account. For individuals, only the aggregate gross receipts from all trades or businesses are considered.

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The IRS issued interim guidance on the definition of gross receipts in March 2017. See Notice 2017-23. In the guidance, the IRS confirmed gross receipts include the following:

• Total sales—defined as the net of returns and allowances

• All amounts received for services 

• Income from investments, including interest income

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The term “gross receipts” means gross receipts as determined under § 448(c)(3) (without regard to § 448(c)(3)(A)) and § 1.448-1T(f)(2)(iii) and (iv) of the Income Tax Regulations. IRS Notice 2017-23 clarifies the definition of gross receipts under § 41(c)(7) and § 1.41-3(c) does not apply for purposes of § 41(h). IRS Notice 2017-23 also does not provide a "de minimis test" in regards to gross receipts.  As it is written, a company receiving minimal gross receipts in the form of bank interest or a dividend in any year prior to the five year period referenced above would be ineligible to elect the payroll tax credit.

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• § 448(c)(3) and § 1.448-1T(f)(2)(iii) define "gross receipts" to include the following:

  • total sales (net of returns and allowances) and all amounts received for services;

  • any income from investments, and from incidental or outside sources; 

    • For example, gross receipts include interest (including original issue discount and tax-exempt interest within the meaning of section 103), dividends, rents, royalties, and annuities, regardless of whether such amounts are derived in the ordinary course of the taxpayer's trade of business.

  • Gross receipts are not reduced by cost of goods sold or by the cost of property sold if such property is described in section 1221 (1), (3), (4) or (5); 

    • With respect to sales of capital assets as defined in section 1221, or sales of property described in 1221 (2) (relating to property used in a trade or business), gross receipts shall be reduced by the taxpayer's adjusted basis in such property. 

  • Gross receipts do not include the repayment of a loan or similar instrument (e.g., a repayment of the principal amount of a loan held by a commercial lender); and 

  • Gross receipts do not include amounts received by the taxpayer with respect to sales tax or other similar state and local taxes if, under the applicable state or local law, the tax is legally imposed on the purchaser of the good or service, and the taxpayer merely collects and remits the tax to the taxing authority. If, in contrast, the tax is imposed on the taxpayer under the applicable law, then gross receipts shall include the amounts received that are allocable to the payment of such tax.

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Although the gross-receipts limitation helps to define a company’s eligibility for the credit, it’s important to note the R&D credit itself isn’t based on gross receipts. The actual credit is based on the company’s eligible R&D expenses.

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Aggregation Rules
All members of a controlled group or trades/businesses under common control (as defined in Treas. Reg. §1.41-6(a)(3)(ii)) are treated as a single taxpayer. This means:

• Gross receipts must be aggregated across all related entities (domestic and foreign)

• The $5 million threshold applies to the combined gross receipts of the group

• The five-year eligibility window applies to the group as a whole

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These rules may limit eligibility for some startups with related entities that had gross receipts more than five years ago.

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Social Security Tax

The payroll tax credit may only be applied against the employer portion of Social Security tax under IRC §3111(f). For 2025, the Social Security tax rate remains 6.2% for both employers and employees. For example, a company with 50 employees earning $75,000 annually would pay approximately $232,500 in employer Social Security taxes.
 

To maximize the payroll offset (up to $500,000 annually), a company would typically need:

• Over $8 million in annual payroll subject to Social Security tax

• At least $3 million in eligible R&D expenses. ​

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Most employers are required to deposit their payroll taxes to the federal government on a monthly or semiweekly basis as well as file a quarterly payroll tax return via Form 941. However, the credit will be applied against the Social Security tax on the quarterly return (not when it’s deposited monthly or semiweekly).

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R&D Tax Credit Payroll Offset: Timing and Procedures to Elect and Claim

Notice 2017-23

On March 30, 2017, the Internal Revenue Service (IRS) issued interim guidance in the form of Notice 2017-23 that describes how eligible small businesses can apply all or part of their research credit against their payroll tax liability pursuant to the Protecting Americans From Tax Hikes Act that was first made available to qualified small businesses filing 2016 federal income tax returns. The notice explains whether your business is a qualified small business, eligible to elect to apply part or all of your research credit against your payroll tax liability, instead of your income tax liability.  Before 2016, taxpayers could only take the research credit against income tax liability. This guidance focuses on the definition of gross receipts, aggregation rules, including the time and manner of making the election to claim the payroll tax credit.   

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The payroll tax credit can apply only against your qualified small business’ liability for the employer portion of social security tax, as imposed by section 3111(a) of the Internal Revenue Code. You may not use the payroll tax credit as a credit against any other employment tax liability and the credit may not be refunded in the absence of liability for your employer social security tax.

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Procedures for an Employer To Claim the R&D Payroll Tax Credit on Form 943 or Form 944

Note, the IRS recently provided notice regarding employers who report their payroll taxes on an annual basis (Forms 943 and 944) may need to adjust the amount reported on Form 8974, line 11, because the qualified small business payroll tax credit for increasing research activities can’t be claimed until the first calendar quarter that begins after the date on which you file your income tax return that makes the election to take the credit against payroll taxes. 

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See IRS update link for additional details: Clarification of Procedures for an Employer To Claim the Qualified Small Business Payroll Tax Credit for Increasing Research Activities on Form 943 or Form 944 (4/24/2018)

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Qualified Small Business Employer Filing Under Own EIN

The election must be made on or before the due date of the taxpayer's income tax return (including extensions) on Form 6765, Credit for Increasing Research Activities, submitted with the return, and can be revoked only with consent. For partnerships and S corporations, the election is made at the entity level. The credit is claimed against payroll taxes on the taxpayer's Form 941, Employer's Quarterly Federal Tax Return, for the first quarter that begins after the income tax return making the election was filed. 

 

For example, if a taxpayer made a payroll tax credit election on a timely filed Form 1120, U.S. Corporation Income Tax Return, that was filed on Oct. 15, 2019, the payroll tax credit would be claimed on the taxpayer's quarterly payroll tax return for the first quarter of 2020. This is accomplished through completing and filing Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, along with the quarterly payroll tax return. Any credit amounts that cannot be used on that quarter's payroll tax return are carried forward to future quarters.

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As a qualified small business with qualifying research expenses, you can apply up to $250,000 of your research credit against your payroll tax liability by taking the following steps:

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Step 1: Complete Form 6765, Credit for Increasing Research Activities, make the payroll credit election (Section D), and attach the completed form to your timely-filed business income tax return.

Step 2: Claim the payroll tax credit by completing Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities. You must attach this form to your payroll tax return, for example, your Form 941, Employer’s Quarterly Federal Tax Return. 

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Aggregate Filers Filing On Behalf Of Clients/Customers

All persons or entities required to be treated as a single taxpayer under the R&D tax credit aggregation rules in Sec. 41(f)(1) are also treated as a single taxpayer for purposes of the payroll tax credit. For example, a startup company formed in 2025 cannot make a payroll tax credit election for the 2025 tax year if a related company with which it is treated as a single taxpayer under the aggregation rules had gross receipts in 2020 or prior. Similarly, a startup company cannot make a payroll tax credit election if a related company with which it is treated as a single taxpayer made a payroll tax credit election in five preceding tax years. Additionally, the potential payroll tax credit that can be elected in a year is allocated among taxpayers treated as a single taxpayer, in proportion to the percentage that each taxpayer's qualified research expenses used in calculating the R&D tax credit is of the group's aggregate qualified research expenses.

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Taxpayers should coordinate with their Professional Employer Organization (PEO), e.g. TriNet, ADP, JustWorks, etc., to claim the payroll tax credit. Note, some PEOs provide online portal access to its users (taxpayers) to update the election to claim the R&D tax credit offset against payroll taxes. However, in general, the PEO is responsible for filing Form 941 (Employer’s Quarterly Federal Tax Return) on behalf of the taxpayer, it will also be responsible for filing Form 8974 (Qualified Small Business Payroll Tax Credit for Increasing Research Activities). The PEO will designate the amount of payroll tax credit elected by the taxpayer in Sec. D of the taxpayer’s Form 6765 by including the taxpayer’s EIN and election amount on the Form 8974 as filed. The instructions for Form 8974 states that a certified PEO is responsible for completing with Form 941, a Schedule R (Allocation Schedule for Aggregate Form 941 Filers), which shows a list of all of the PEO’s clients. The instructions further state that the PEO is responsible for attaching a Form 8974 for each client that elects the qualified small business payroll tax credit.

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If you are a Section 3504 agent or a Certified Professional Employer Organization (CPEO), you may claim the payroll tax credit on behalf of a qualified small business client that elects to apply the research credit against payroll tax liability.  For you to claim the credit, your client must be a qualified small business and must elect to apply the research credit against payroll tax liability by attaching Form 6765 to its timely-filed business income tax return.  To claim the credit on behalf of a client:

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Step 1: Claim the Qualified Small Business Payroll Tax Credit for Increasing Research Activities on a Form 941 filed under the Section 3504 agent’s or CPEO’s Employer Identification Number (EIN).

Step 2: Complete and attach Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, when filing an aggregate Form 941.

Step 3: Attach a Form 8974 for each qualified small business client opting to apply the research credit against payroll tax liability.

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If you are a Non Certified PEO (including CPEO applicants not yet certified) that pays wages to individuals as part of the services provided to a client pursuant to a service agreement, such as collecting, reporting and/or paying or depositing employment taxes with respect to such wages, you may claim the payroll tax credit on behalf of a qualified small business client.  For you to claim the credit, your client must be a qualified small business and must elect to apply the research credit against payroll tax liability by attaching Form 6765 to its timely-filed business income tax return.  To claim the credit on behalf of a client:

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Step 1: Claim the Qualified Small Business Payroll Tax Credit for Increasing Research Activities on a Form 941 filed under the PEO’s EIN.

Step 2: Complete and attach Schedule R (Form 941) listing those clients electing to claim the Qualified Small Business Payroll Tax Credit for Increasing Research Activities and report the corresponding credits and all other amounts allocated to the listed clients. Check the ‘Section 3504 Agent’ box for ‘Type of filer’ at the top of the Schedule R. Enter the total wages and taxes paid for all other clients not separately listed on Schedule R and for your own employees on line 13 of Schedule R, so that the totals shown on line 14 match the amounts reported on the corresponding lines on Form 941.

Note: This required step for Non-Certified PEOs provides the necessary substantiation to enable the IRS to apply each client’s research credit against the payroll tax liability reported on Form 941 under the PEO’s EIN.

Step 3: Complete and attach Form 8974 for each client listed on Schedule R (Form 941).​

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