R&D Tax Credit Potentially Doubled With Inflation Reduction Act

On August 18, 2022,  President Biden signed the Inflation Reduction Act into law. This act has a lesser-known provision that may benefit many small business startups, allowing them to potentially double the amount they can claim on the research and development tax credit from $250,000 to $500,000 per year against payroll taxes. Under current law, small businesses that may not have enough income tax liability to take advantage of their research and development credit can apply up to $250,000 of the credit toward their Social Security payroll tax liability.

To qualify for the expanded credit, the small business would need less than $5 million of gross receipts and be less than five years old. The Inflation Reduction Act would permit an additional credit of up to $250,000 to be applied against the Medicare payroll tax for tax years starting after December 31, 2022. The expanded R&D tax credit will not show up on tax returns until 2024 since it can first be claimed for tax year 2023, but it could boost small businesses, particularly the startups it can incentivize.

Many are waiting for additional guidance on claiming the tax credit to be released by the Internal Revenue Service and the Treasury Department. As more details will be needed, the Inflation Reduction Act essentially raises the cap for small businesses from $250,000 to $500,000, which will be allowed against the Medicare hospital insurance coverage. A recent study shows that only about half the people who are qualified to take the credit actually take it. With more opportunities coming to use the credit and the higher limits, many more opportunities will be created to fund innovation for today’s R&D customers. 

However, there will be some hurdles as the IRS has been increasing the requirements lately for documenting R&D activities. A September 2021 memorandum from the IRS Office of Chief Counsel said it wants more detailed information about all the business components for that year’s research credit claims. For each business component, companies will need to identify all the research activities they have performed and name the individuals who performed each research activity, along with the information each individual sought to discover. Refund claims for the research and development credit will also need to detail the total qualified employee wage expenses, total qualified supply expenses, and total qualified contract research expenses for the claim year, using Form 6765. The additional requirements have led to some consternation among companies and tax professionals. However, expanding the R&D credit under the Inflation Reduction Act should spur more interest in claiming the credits among companies, especially tech startups.

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