The Inflation Reduction Act of 2022 will double the maximum R&D tax credit that a startup can take to reduce their payroll taxes from $250,000 to $500,000. Since the tax credit is taken against payroll taxes, even unprofitable startups can take advantage of this incentive and reduce their burn rate.
The credit is roughly 10% of qualifying R&D, and was capped at $250,000. The Inflation Reduction Act of 2022 increases this cap to $500,000, meaning that startups that meet the maximum will be able to reduce their payroll taxes by half a million dollars – a substantial amount!
The IRS defines “qualifying” R&D as research and development that passes a four part-test. Roughly, this four part test is comprised of:
- Qualified purpose: Tinkering is not allowed – the project must be specific and defined.
- Elimination of uncertainty: The project must be legitimately advancing the “science” of the company’s business or products.
- Experimental: The company must document that it is using either a scientific method or trial and error process.
- Technical: the project has to be in the hard sciences like biology or engineering (note that computer science/software engineering can count under the right circumstances).
Many activities conducted by the development teams at startups do NOT count under the IRS’ definitions, such as research after commercial production, studies and surveys, reverse engineering, and more.
For assistance with R&D tax credit, contact the R&D Tax Credit Specialists today.