South Carolina Startups Could Save an Extra $250,000 Per Year, up to $2.5MM
Submitted by Margaret Krajcer JD, Vice President and General Counsel of Tax Credits Group
On August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (IRA). Within the new law was an enhanced provision to the Federal Research and Development (R&D) Tax Credit which doubles the amount of credit a startup business can use to offset payroll taxes, up to $500,000. Further, any credits which are not elected against these payroll taxes can be applied to the general business credit, which means they can be carried-forward into the future for up to 20 years.
These new provisions have received little attention compared to other more expansive parts of the IRA. However, they represent great news for many early-stage companies located within the great state of South Carolina—especially newly founded tech, advanced manufacturing, and medical device companies who are often investing aggressively in R&D during their early years.
To understand why this new law change is so impactful, it’s important to take a quick look back at the history of the Federal R&D Tax Credit.
Until 2016, startup companies performing R&D were not truly able to benefit from the credit because it could only be used to offset income tax or alternative minimum tax. Since most early-stage startups are not profitable, they do not pay income tax, and thus there was little incentive for them to claim the credit. Even with the 20-year carry-forward provision, the delayed benefit often negated the interest from these companies to claim it. As a result, the businesses that desperately needed cash to continue doing some of the most exciting R&D simply could not justify claiming a credit that would benefit them 10, 15 or even 20 years to come.
Congress eventually recognized the shortcomings of the existing tax law. In 2015 they passed the Protecting Americans From Tax Hikes (PATH) Act, which created a new provision allowing startups to utilize up to $250,000 of R&D tax credits against the 6.2% employer portion of their FICA taxes. The ability to offset these payroll taxes created an immediate ability for startups to benefit from the R&D tax credit.
While this was incredibly favorable for businesses, larger-scale startups paying high wage amounts to bring aboard highly skilled employees were still somewhat limited by the $250,000 cap. Legislators once again recognized these shortcomings and began to advocate for new rules that allowed even greater credit utilization for startups.
The new IRA Act finally provided a place to act on these ideas, creating the new rules allowing startups to offset an additional $250,000 of credit against the 1.45% employer portion of Medicare taxes. For eligible startups who are able to max out this opportunity, this means the new annual credit cap is $500,000 for up to five years. In theory, an early-stage startup that has not yet claimed this credit may now have the opportunity to offset up to $2.5M in tax liability.
The nuances behind how the filing of the credit claim on Form 941 actually works is still not known, nor is it yet clear if a taxpayer must 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. It is expected that in the coming weeks, the IRS will issue additional guidance on this topic.
Nevertheless, these changes will undoubtedly allow innovative startup companies fighting to grow aggressively to further invest in R&D, and it’s likely to drive larger-scale startups to accelerate their product development roadmaps and timelines. That’s good news for them. It’s also good news for our economy since every dollar that remains in the hands of these growing startups helps drive further innovation and job creation.
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.