The payroll tax offset and start-ups (brief) | Research Credit Integrity Alliance

Key points

A qualified small business can elect to apply up to $500,000 of its research credit a year, for tax years beginning after 2022, against the employer share of social security and Medicare tax.12
The credit is used from the first quarter after the income tax return is filed, so a start-up with no income tax to pay can use it within months.23
The Treasury Inspector General reported in 2018 and again in 2026 that the IRS lacked a process to identify ineligible businesses claiming the offset after processing.45
Start-ups making the election are generally exempt from Section G of Form 6765, and no form asks how the claim's preparer was paid.6
If the credit is later reduced, the company, not its adviser, bears the recapture.17

How the offset works

The federal research credit under Section 41 is an income tax credit. A company with no income tax to pay cannot use it in the year it is earned. Section 41(h), added by the Protecting Americans from Tax Hikes Act of 2015, lets a qualified small business elect to apply part of its credit against payroll taxes instead.13 The IRS describes the election as designed to benefit a start-up that has little or no income tax liability.3

A qualified small business has gross receipts of less than $5 million for the year and no gross receipts for any year before the five taxable year period ending with that year.1 The election is made on Form 6765 attached to a timely filed original return, and the IRS states that it cannot be made on an amended return.36 A business may not make it if it has already made it for five or more earlier years.1

The amount elected was limited to $250,000 and, for tax years beginning after 2022, to $500,000.13 Under Section 3111(f), the credit reduces the employer share of social security tax, up to the original $250,000 limit, and then the employer share of Medicare tax, starting in the first calendar quarter that begins after the return is filed.2 The company claims it on Form 8974 attached to its employment tax return, and any unused amount carries to the next quarter.28

What the record shows

The Treasury Inspector General for Tax Administration recorded over 2,200 claims totaling over $53.2 million for Tax Year 2017.4 By June 2025 the IRS had received 11,416 Forms 941 with $382 million in payroll tax credit for Tax Year 2023, and 12,612 with $381 million for Tax Year 2024.5

In 2018 the Inspector General identified 143 businesses that claimed or received about $11.8 million in potentially erroneous credits.4 In 2026 it found that the IRS "still does not have processes to address ineligible taxpayers" who claim the offset, and identified 40 businesses that did not meet the gross receipts test and were allowed $3.1 million.5 It also stated that most businesses claiming the offset are eligible.5

Those reviews dealt with eligibility, not with whether the underlying research was correctly claimed. No official publication found for this brief reports how payroll offset claims are prepared or how their preparers are paid.

Why fees matter more here

The credit is near term cash. Because the credit reduces payroll tax within months of filing, the effect of a larger claim is felt at once.28

The form asks less. For tax years beginning after 2025, a qualified small business that claims the payroll tax credit, and a smaller taxpayer reporting on an original return, need not complete the business component detail in Section G.6

The company carries the downside. Section 41(h)(6)(C) provides for regulations to recapture the payroll tax benefit if the credit is later adjusted, and Notice 2017-23 asked for comments on how recapture should work.17 Nothing in Sections 41(h) or 3111(f) moves that liability to the preparer.12

The fee rules have gaps. Circular 230 bars practitioners from charging contingent fees for preparing original returns, and the AICPA Code bars its members from preparing an original or amended return or refund claim for a contingent fee.910 A federal court held in 2014 that the IRS lacks authority to regulate the preparation of ordinary refund claims, and its reasoning rested on an appeals court decision that the IRS could not regulate tax return preparers.11 A preparer outside both sets of rules is subject to the Internal Revenue Code's preparer penalties but not to those fee limits.12

The case for success fees

Start-ups agree to contingent fees for real reasons: no cash is needed up front, the adviser bears the cost if no credit results, the fee moves with the benefit, and the company gains access to expertise it could not otherwise afford. Nothing in this brief suggests that advisers who charge them act improperly. The answer is about the incentive. The adviser's risk is that the fee is not earned; the company's risk is that the credit does not survive examination and must be repaid. A fee calculated on the amount claimed rewards the first, not the second.

Our position

Congress should prohibit contingent fees, commonly called success fees, in federal research and development tax credit engagements under Section 41, so that advisers are paid for the work they perform rather than for the size of the claim they produce. That includes preparing a qualified small business's credit and payroll tax election. Swanson Reed, which publishes this brief, is a fixed-fee R&D tax adviser with a direct commercial interest: it does not charge success fees, and a ban would remove a pricing model it competes against.

References

Office of the Law Revision Counsel, 26 U.S.C. 41, Credit for increasing research activities, subsection (h), United States Code 2024 edition published by the Government Publishing Office. https://www.govinfo.gov/content/pkg/USCODE-2024-title26/html/USCODE-2024-title26-subtitleA-chap1-subchapA-partIV-subpartD-sec41.htm (accessed 11 October 2026). Back
Office of the Law Revision Counsel, 26 U.S.C. 3111, Rate of tax, subsection (f), United States Code 2024 edition published by the Government Publishing Office. https://www.govinfo.gov/content/pkg/USCODE-2024-title26/html/USCODE-2024-title26-subtitleC-chap21-subchapB-sec3111.htm (accessed 11 October 2026). Back
Internal Revenue Service, Qualified small business payroll tax credit for increasing research activities (page last reviewed or updated 28 June 2026). https://www.irs.gov/businesses/small-businesses-self-employed/qualified-small-business-payroll-tax-credit-for-increasing-research-activities (accessed 11 October 2026). Back
Treasury Inspector General for Tax Administration, Processes Are Needed to Identify Small Businesses Erroneously Claiming the Research Tax Credit Payroll Tax Offset, Reference Number 2019-40-014 (19 December 2018), Highlights. https://www.tigta.gov/sites/default/files/reports/2022-02/201940014fr.pdf (accessed 11 October 2026). Back
Treasury Inspector General for Tax Administration, Controls for the Qualified Small Business Payroll Tax Credit Were Updated, but Ineligible Taxpayers Continue to Receive the Credit, Report Number 2026-408-012 (15 April 2026), Highlights and pages 1 to 4. https://www.tigta.gov/sites/default/files/reports/2026-04/2026408012fr.pdf (accessed 11 October 2026). Back
Internal Revenue Service, Instructions for Form 6765 (Rev. December 2025), "Payroll Tax Credit Election" and "Requirements To Complete Section G". https://www.irs.gov/instructions/i6765 (accessed 11 October 2026). Back
Internal Revenue Service, Notice 2017-23, Interim Guidance on Payroll Tax Credit Election, Internal Revenue Bulletin 2017-16, section 6. https://www.irs.gov/irb/2017-16_IRB (accessed 11 October 2026). Back
Internal Revenue Service, Instructions for Form 8974 (Rev. December 2024), "Who Must File Form 8974?" and "When Must You File?". https://www.irs.gov/instructions/i8974 (accessed 11 October 2026). Back
Treasury Department, Regulations Governing Practice before the Internal Revenue Service (Circular 230), 31 CFR 10.27, Fees, paragraphs (b) and (c). https://www.ecfr.gov/current/title-31/subtitle-A/part-10/section-10.27 (accessed 11 October 2026). Back
American Institute of Certified Public Accountants, AICPA Code of Professional Conduct (updated for all official releases through September 2026), ET 1.510.001 Contingent Fees Rule, paragraph .01. https://pub.aicpa.org/codeofconduct/ethicsresources/et-cod.pdf (accessed 11 October 2026). Back
US District Court for the District of Columbia, Ridgely v. Lew, Civil Action No. 1:12-cv-00565 (CRC), Memorandum Opinion, 16 July 2014, pages 1 to 2 and 8 to 9. https://www.govinfo.gov/content/pkg/USCOURTS-dcd-1_12-cv-00565/pdf/USCOURTS-dcd-1_12-cv-00565-1.pdf (accessed 11 October 2026). Back
Office of the Law Revision Counsel, 26 U.S.C. 6694, Understatement of taxpayer's liability by tax return preparer, subsections (a), (b) and (e), United States Code 2024 edition published by the Government Publishing Office. https://www.govinfo.gov/content/pkg/USCODE-2024-title26/html/USCODE-2024-title26-subtitleF-chap68-subchapB-partI-sec6694.htm (accessed 11 October 2026). Back