The Inflation Reduction Act doubled the research and development tax credit from $250,000 to $500,000. Here's what you need to know.
Spending on research and development has never been sweeter.
The $437 billion Inflation Reduction Act, signed into law on August 16, 2022 authorized a swath of perks for small businesses to sink their teeth into. They range from incentives to switch to energy-efficient buildings and vehicles to extending premium tax credits for Affordable Care Act health plans. The IRA also doubled the federal payroll tax credit to $500,000, from $250,000.
The Biden administration’s goal in increasing the credit’s ceiling is to encourage innovation, research, and experimental expenditures, according to Phillip Ross, an accounting and audit partner at Anchin, a New York-based accounting firm. The R&D tax credit is geared towards companies creating new products, processes, and techniques, or improving on existing ones.
While the credit is now even more attractive, it’s not guaranteed, and businesses have been turned away before. Here’s how to boost your chances and some other factors to keep in mind.
Don’t self eliminate.
Eligible small businesses can take advantage of the larger tax credit beginning in 2023. Qualifying companies must have $5 million or less in revenue and no more than five years of generating gross receipts, including the current year. While a business can claim the credit through IRS Form 6765, the credit is only offered in 35 states. Each state has its own tax laws and regulations that don’t follow some federal tax codes, Ross says. See if your business is in a qualifying state at this interactive map.
The biggest impediment to getting the credit is often internal—that is, you think you’re not eligible when you are. That’s a costly mistake. “It used to be thought that you had to be a scientist with a lab coat to be able to qualify for research development, and that’s really not the case,” Ross explains.
Pursue a formal research study.
Ross says that a company needs to carry out a formal research and development credit study to substantiate the credit amount for the IRS. The study can be done internally or externally through a third party that can verify R&D expenditures. The study takes a company’s expenses into consideration, which helps determine the amount of credit it is eligible to receive. “The earlier you get your taxes done and the earlier you get the credit study done, the sooner you can access these credits and reduce the amount of payroll tax you have to pay,” Ross says.
It’s not a one-time deal.
Businesses can take advantage of the credit each year for up to five years. That means that companies receiving the full tax benefit can save up to $2.5 million across a five-year period. Businesses need to report the credit on their company’s federal tax returns: C-corps should see the credit directly on their return, while pass-through entities, such as S-corps, will see the credit reflected on the Schedule K-1 form.
But it’s important to document anything related to R&D within your organization to make your case, so hang onto payroll records, lab results, details about projects, and any other documentation related to your R&D.
You should hang onto those records even after receiving the credit, as the IRS can pay closer attention to your company for an audit. And yes, the credit can technically be clawed back if your company can’t produce relevant records upon request if an audit pops up.
“If the IRS does decide to come audit you, they’re looking for contemporaneous documentation,” Ross says. “They’re really looking to see how this ties into the work that you’re doing for clients and to see that you’ve met all the steps that this is actually experimentation.”
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