Most news coverage surrounding the recently signed Inflation Reduction Act (IRA) focused on its health care and climate change sections. However, the measure also improves a frequently disregarded federal tax credit for qualified small businesses. For tax years beginning after 2022, the IRA more than doubles the amount that an eligible firm may be able to deduct as a research and development (R&D) tax credit to offset its payroll tax. However, there is a maximum of up to $2.5 million over five years. The credit allows a qualified business to leverage the R&D tax benefit even with little to no income tax liability. This benefit could potentially free up significant cash flow.

The IRA expansion

An eligible small business could utilize its R&D credit against only the 6.2% Social Security tax under the Protecting Americans from Tax Hikes (PATH) Act. However, starting with the tax year 2023, qualified firms can deduct an extra $250,000 from their 1.45% Medicare tax obligation.

Although the overall credit limit is now $500,000, it is split into two halves. As a result, the maximum amount you can deduct from your FICA and Medicare payroll tax liabilities is $250,000 each.

You can only use the credit for up to five years, much like the PATH Act. Current aggregation regulations, which count affiliated organizations as a single taxpayer when calculating gross receipts, are still in effect. The entities decide how to distribute any credit, but each organization is required to do it independently.

Claiming the R&D credit

By having us fill out the relevant section of Form 6765, “Credit for Increasing Research Activities,” and including it with your income tax return, you can choose to get a payroll tax credit. Then, you fill out Form 8974, “Qualified Small Business Payroll Tax Credit for Increasing Research Activities.” You must include Form 8974 with your employment tax return to receive the credit.

You may use the credit to offset payroll tax no sooner than the first quarter following the filing of the return stating the election. For any calendar quarter, the credit cannot exceed the tax owed. You can carry forward any unused amounts.

What if you previously qualified for the R&D credit but didn’t claim it? The IRS has recently strengthened the criteria for requesting a refund of the R&D credit.

A refund claim must:

1. Identify all the company products and processes that the Section 41 research credit claim pertains to for the applicable year to be considered satisfactory
2. List all research activities, the people who carried out each activity, and the knowledge that each person intended to learn for each business product and process
3. List all of the qualified expenses for supplies, qualified employee wages, and qualified contract research for the claim year (you can use Form 6765 for this)

You must include these so-called “pieces of information” with the reimbursement application. A declaration attesting to their accuracy and signed under penalty of perjury is also a requirement. In addition, you will receive a letter giving you 45 days to correct any deficiencies if your reimbursement claim is insufficient.

More on the payroll tax credit

The IRS should release updated tax forms for 2023 and information on the enhanced small business R&D tax credit. Contact our RRBB accountants and advisors if you believe you could be eligible today or in the past. In the meantime, keep an eye out for part two of this blog post series!

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