SECTION 2. BACKGROUND

Sections 41(h) and 3111(f) were enacted by section 121(c) of the Protecting Americans from Tax Hikes Act of 2015, Pub. L. No. 114–113, Div. Q, 129 Stat. 2242. Section 41(h)(1) provides that at the election of a qualified small business for any taxable year, § 3111(f) shall apply to the payroll tax credit portion of the research credit for the taxable year and such portion shall not be treated (other than for purposes of § 280C) as a research credit.

Section 41(h)(2) provides that the payroll tax credit portion of the research credit with respect to any qualified small business for any taxable year is the least of (A) the amount specified in the payroll tax credit election, (B) the research credit for the taxable year (determined before the application of § 41(h)), or (C) in the case of a qualified small business other than a partnership or S corporation, the amount of the business credit carryforward under § 39 carried from the taxable year (determined before the application of § 41(h) to the taxable year).

Under § 41(h)(3)(A)(i), a “qualified small business” means, with respect to any taxable year, a corporation or partnership if (I) the gross receipts (as determined under the rules of § 448(c)(3), without regard to subparagraph (A) thereof) of such entity for the taxable year are less than $5,000,000, and (II) such entity did not have gross receipts (as so determined) for any taxable year preceding the 5–taxable-year period ending with such taxable year. In addition, under § 41(h)(3)(A)(ii), a “qualified small business” includes any person (other than a corporation or partnership) who meets the requirements of § 41(h)(3)(A)(i)(I) and (II), determined by substituting “person” for “entity” each place it appears, and by taking into account only the aggregate gross receipts received by such person in carrying on all the trades or businesses of such person. Under § 41(h)(3)(B), a “qualified small business” shall not include an organization that is exempt from income taxation under § 501.

Section 41(h)(4)(A)(i) provides that any payroll tax credit election shall specify the amount of the research credit to which the election applies. Section

41(h)(4)(A)(ii) provides that any payroll tax credit election shall be made on or before the due date (including extensions) of (I) in the case of a qualified small business that is a partnership, the return required to be filed under § 6031 (for example, the Form 1065 or successor form), (II) in the case of a qualified small business that is an S corporation, the return required to be filed under § 6037 (for example, the Form 1120–S or successor form), and (III) in the case of any other qualified small business, the return of tax for the taxable year. Section 41(h)(4)(A)(iii) provides that, once made by a taxpayer, a payroll tax credit election may be revoked only with the consent of the Secretary.

Under § 41(h)(4)(B)(i), the amount specified in any payroll tax credit election shall not exceed $250,000. Section 41(h) (4)(B)(ii) provides that a person may not make a payroll tax credit election if such person (or any other person treated as a single taxpayer with such person under § 41(h)(5)(A)) has made a payroll tax credit election for 5 or more preceding taxable years.

Section 41(h)(4)(C) provides that, in the case of a qualified small business that is a partnership or S corporation, the payroll tax credit election shall be made at the entity level.

Section 41(h)(5)(A) provides that, except as provided in § 41(h)(5)(B), all persons or entities treated as a single taxpayer under § 41(f)(1) shall be treated as a single taxpayer for purposes of § 41(h). Section 41(h)(5)(B)(i) provides that, for purposes of §§ 41(h) and 3111(f), each of the persons treated collectively as a single taxpayer under § 41(h)(5)(A) may separately make the payroll tax credit election for any taxable year. Section 41(h)(5)(B)(ii) provides that, for purposes of §§ 41(h) and 3111(f), the $250,000 amount under § 41(h)(4)(B)(i) shall be allocated among all persons treated collectively as a single taxpayer under § 41(h)(5)(A) in the same manner as under § 41(f)(1)(A)(ii) or (B)(ii), whichever is applicable.

Section 41(h)(6) instructs the Secretary to prescribe regulations as may be necessary to carry out the purposes of § 41(h), including (A) regulations to prevent the

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avoidance of the purposes of the limitations and aggregation rules through the use of successor companies or other means, (B) regulations to minimize compliance and recordkeeping burdens under § 41(h), and (C) regulations for recapturing the benefit of payroll tax credits in cases where there is a subsequent adjustment to the payroll tax credit portion of the research credit, including requiring amended income tax returns in the cases where there is such an adjustment.

Section 3111(f)(1) provides that, in the case of a taxpayer who has made a payroll tax credit election for a taxable year, there shall be allowed a payroll tax credit for the first calendar quarter which begins after the date on which the taxpayer files the return specified in § 41(h)(4)(A)(ii) in an amount equal to the payroll tax credit portion of the research credit determined under § 41(h)(2).

Under § 3111(f)(2), the payroll tax credit shall not exceed the employer portion of social security tax imposed for any calendar quarter on the wages paid with respect to the employment of all individuals in the employ of the employer.

Section 3111(f)(3) provides that if the amount of the payroll tax credit exceeds the limitation of § 3111(f)(2) for any calendar quarter, such excess is carried to the succeeding calendar quarter and allowed as a payroll tax credit for such quarter.

Section 3111(f)(4) provides that the payroll tax credit shall not be taken into account for purposes of determining the amount of any deduction allowed under chapter 1 of subtitle A of the Code for the employer portion of social security taxes.

The Treasury Department and the IRS recognize that businesses need immediate guidance to determine their eligibility for the payroll tax credit election with respect to taxable years beginning in 2016, and the procedures for making the election and claiming the credit. In response to Notice 2016–26, 2016–14 I.R.B. 533, which requests recommendations for the 2016–2017 Priority Guidance Plan, several commenters requested guidance under §§ 41(h) and 3111(f). In particular, commenters requested guidance regarding the term “gross receipts” for purposes of determining whether a business is a “qualified small business” under § 41(h)(3). In addition, commenters requested guidance

regarding controlled groups of corporations and groups of trades or businesses under common control (collectively referred to as controlled groups) in the context of § 41(h). Because immediate guidance is necessary, this notice prescribes interim guidance in sections 3 and 4 regarding the definition of “qualified small business” and the time and manner of making the payroll tax credit election. Further, because the Treasury Department and the IRS are developing guidance under § 41(h), the Treasury Department and the IRS request comments in section 6 of this notice on the interim guidance provided in this notice and other issues under § 41(h) that may require additional guidance.