The Inflation Reduction Act brought good news to small businesses that want to claim the Research and Development Tax Credit. Qualified small businesses can use the research credit against payroll taxes instead of income tax. The Inflation Reduction Act improved this option by increasing the limit from $250,000 annually to $500,000.

What Businesses Qualify?

A business must not have more than five years of gross receipts and less than $5 million in gross receipts each year to use the research credit against payroll taxes. Many companies do not have enough income tax liability to fully utilize their research credit, and the payroll election provides an alternative way to benefit from the credit.

How to Use the Credit?

Once elected, the credit can be utilized against their Social Security payroll tax liability of up to $250,000. The expansion allows an additional $250,000 to offset the Medicare payroll tax liability. The increase is not effective until the tax year 2023 and, as a consequence, will not benefit companies until the 2024 filing season. Before then, the IRS will need to issue new guidance and update the forms and instructions allowing companies to properly claim the credits.

Don’t Forget Documentation

The research credit has long been a focus of the IRS. Last year, the Service increased documentation requirements for companies claiming credits on amended returns. While there has not been a similar push for the payroll credit, it could happen. Companies must document their qualified activities and be ready for an IRS examination if they claim the research credit.

If you are questions about the research credit or need help with an IRS exam, contact us today to set up a time to talk.

Photo by Ousa Chea on Unsplash