The recently enacted Inflation Reduction Act of 2022 contains several new environment-related tax credits that are of interest to individuals and small businesses. The Act also extends and modifies some preexisting credits. Of particular interest to payroll professionals is the increase in the qualified small business payroll tax credit for increasing research activities.
Under pre-Inflation Reduction Act law, a “qualified small business” (QSB) with qualifying research expenses could elect to claim up to $250,000 of its credit for increasing research activities as a payroll tax credit against the employer’s share of Social Security tax.
Due to concerns that some small businesses may not have a large enough income tax liability to take advantage of the research credit, for tax years beginning after December 31, 2022, QSBs may apply an additional $250,000 in qualifying research expenses as a payroll tax credit against the employer share of Medicare. The credit can’t exceed the tax imposed for any calendar quarter, with unused amounts of the credit carried forward.
There are several forms involved in reporting and claiming the payroll research tax credit. Form 941, 943 and 944 are used by employers to report the credit to the IRS. Form 6755 is used determine and claim the credit for increasing research activities. Form 8974 is used to determine the amount of the qualified small business payroll tax credit for increasing research activities that an employer can claim on Form 941. Due to the increase in the payroll research tax credit that can be claimed against Medicare taxes, the IRS is likely to revise these forms and/or their instructions in the near future. There may be new guidance on this increase as well.
“In-house” research expenses that can qualify for the research credit are:
(1) any “wages” paid or incurred to an employee for “qualified services” performed by the employee;
(2) any amount paid or incurred for “supplies” used in the conduct of qualified research and,
(3) under IRS regs, any amount paid or incurred to another person for the right to use computers in the conduct of qualified research.
In no event are depreciation, overhead costs, general, administrative, or other indirect expenses included as in-house expenses.
Supplies under (2) above, and computers under (3) above, are used in the conduct of qualified research if they are used in the performance of qualified services by an employee of the taxpayer (or by a person acting in a capacity similar to that of an employee of the taxpayer). Here, qualified services are determined without regard to the rule requiring allocation of wages between qualified and nonqualified services performed where substantially all the services performed are qualified services.
Except for any amount paid or incurred to another person for the right to use (time-sharing) computers in the conduct of qualified research, qualified research expenses do not include amounts paid or incurred for the use of personal property, e.g., for renting research equipment. This is intended to end the inconsistent treatment of earlier law that permitted rents to qualify for the credit but not depreciation on purchased research equipment.
The computer must be owned and operated by someone other than the taxpayer, located off the taxpayer’s premises, and the taxpayer must not be the primary user of the computer.
An amount paid or incurred under (3), above, includes any amount to the extent that the taxpayer (or any person with whom the taxpayer must aggregate expenditures) receives or accrues any amount from any other person for the right to use substantially identical personal property.
A payment to “another person” for the right to use personal property in the conduct of qualified research means a payment to a person other than the taxpayer. An intercompany charge isn’t an amount paid or incurred to “another person.”.