Inflation Reduction Act Potentially Doubles Research &
Development Credit for Select Small Businesses

The Inflation Reduction Act that President Biden signed into law has a lesser-known provision that could 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 to have 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 Dec. 31, 2022.

The expanded R&D tax credit probably won’t 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 that it can incentivize.

The bill essentially raises the cap for small businesses from $250,000 today to be applied to payroll taxes, primarily FICA, to an additional $250,000 that will be allowed against the Medicare hospital insurance coverage. However, current research shows that only about half the people who are qualified to take the credit actually take the credit. The more opportunities to use the credit and the higher limits that people can claim will expand the overall market and create more opportunity to fund innovation for today’s R&D customers.

There will be some hurdles as the IRS has been increasing the requirements lately for documenting R&D activities.

The IRS will require more detailed information about all the business components for which the research credit claims relate for that year.  For each business component, companies will need to identify all the research activities they’ve 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 IRS Form 6765. The additional requirements have led to some consternation among companies and tax professionals. But the expansion of the R&D credit under the Inflation Reduction Act should spur more interest in claiming the credits among companies, especially tech startups.

We expect to see additional guidance on claiming the tax credit to be released by the Internal Revenue Service and the Treasury Department.

The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.