By Margaret Krajcer
Innovative Ohio startups will soon have the ability to save up to $500,000 a year on their payroll taxes.
On Aug. 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (IRA). Contained within the law was a provision to the Federal Research and Development (R&D) Tax Credit, which doubles the amount of credit an early-stage startup company can use to offset payroll taxes, up to $500,000.
Prior to the IRA Act, startups earning R&D credit could use it to offset up to $250,000 of payroll taxes annually for up to 5 years. More specifically, the credit had to be applied against the 6.2% employer portion of their FICA taxes. Now, under this new Act, startups can offset an additional $250,000 of credit for up to 5 years against the 1.45% employer portion of Medicare taxes. For eligible startups able to max out this incentive, this will equate to a bottom-line payroll tax savings of $2.5MM. Even better, because the R&D tax credit is part of the general business credit, startups who happen to find themselves with credit in excess of the $500,000 annual cap will also be able to carry it forward for up to 20 years.
This enhanced provision will surely benefit larger-scale startups in Ohio, especially those in the biotech, medical device, and software development sectors, as these industries are most often investing aggressively in R&D during their early years. To support these R&D efforts, these companies employ highly skilled, well-paid technical staff and, thus, are often susceptible to high payroll taxes. Access to an extra $500K a year will undoubtedly allow these innovative companies to invest further in R&D, while the limited five-year window of opportunity is also likely to drive some startups to accelerate their development roadmaps.
This new law is effective for tax years beginning on or after Jan. 1, 2023. At this time, current legislation does not clarify if a taxpayer will need to max out the 6.2% employer portion of their FICA taxes before credit can be earned against the 1.45% employer portion of Medicare taxes. What is known, however, is that taxpayers are required to elect the payroll offset on an originally filed tax return (Form 6765). And that credit earned can offset payroll taxes no earlier than the first quarter after the taxpayer files the tax return reporting the R&D credits. (For example, a taxpayer filing on Sept. 15, 2024, will not be able to utilize the credit to offset payroll taxes until Q4 2024.) It is anticipated that the IRS will issue further guidance in the coming weeks, as well as revised tax forms for the 2023 tax year.
Margaret Krajcer is JD, Vice President and General Counsel of Tax Credits Group. With office locations in Ohio and South Carolina, TCG specializes in federal and state R&D tax credits and the Employee Retention Credit. She can be reached at firstname.lastname@example.org.