Inflation Reduction Act: What Startups Need to Know

The Inflation Reduction Act is a sweeping $750 billion health care, tax, and climate bill that was signed into law on August 16, 2022. There is a lot of news about this significant legislation and what it’s doing for lowering drug costs and subsidizing clean energy. One topic that isn’t getting enough attention, however, is that this bill is big news for small businesses and startups. To put it simply, the bill impacts the research and development tax credit. It increases the amount of money startups are able to claim, and broadens the scope of what that money can be used to offset.  

A little background 

The R&D Tax Credit was created to encourage and ignite innovation within American businesses. Originally introduced as part of the Economic Recovery Tax Act of 1981, this credit has been extended many times over the years, eventually becoming a permanent tax credit in 2015.

Currently, startups have a unique advantage when it comes to the R&D tax credit. Young companies with less than $5 million in gross receipts and gross receipts for less than 5 years can use the R&D tax credit to offset payroll taxes (primarily FICA) up to $250,000 per year. But only about half of the businesses that qualify actually apply for the credit, oftentimes because they are unaware that they are eligible.

So, what qualifies as research and development? 

Quite a lot, actually. Creating a new formula for your beer? That’s R&D. Manufacturing a new material? That counts too. Developing new e-commerce software? Yep, that’s R&D. There is a four-part test that will generally help you to know if you qualify. Learn more about that here. 

What’s changed with the Inflation Reduction Act? 

This law showed a renewed commitment to innovation and, in particular, to startups and small businesses. There are three main changes to the tax credit that affect these businesses: 

• The credit amount is doubled. 

Yes, you read that right. Doubled. Now, rather than claiming up to $250,000 per year, qualifying startups and small businesses can claim up to $500,000. This can make all of the difference to a small business looking to innovate in their field. 

• The credit can now be applied to Medicare. 

Now, the additional $250,000 can be applied against the employer portion of the Medicare payroll tax liability. This is an expansion from the previous version of the credit which only allowed businesses to offset the Social Security portion of their payroll tax.  

• There is an increase in IRS funding. 

You might be wondering why this matters, or worse, you might assume that it means an increased chance of an audit. The biggest budget increase is to modernize their systems. However, this increase in funding is one more reason to ensure you’re calculating and documenting  your eligible R&D work correctly. Find out more about defensibility.

The bottom line

The Inflation Reduction Act is helping small businesses innovate and advance like never before. Taking advantage of this tax credit can feel overwhelming, but if you select a practitioner with valuable expertise and a proven track record in the R&D arena, you can have peace of mind while getting the credit you deserve for all you do. Clarus R+D is here to help. You deserve to get credit for all you do, and we want to help you get it.