Research & Development (R&D) Credits

R&D credits are available to any U.S.-based business incurring expenses while developing new or improved products on domestic soil. The Internal Revenue Service (IRS) provides a four-part test to determine your company’s eligibility:

1. Eliminate uncertainty. The research must be carried out in order to eliminate uncertainty about the development of your product or process.
2. Process of experimentation. You must show that activities include experimentation to resolve the uncertainty.
3. Technological in nature. Your research must rely on “hard sciences,” such as engineering, chemistry, or computer science.
4. Qualified purpose. The activity must be for the creation of a new or improved product for your business.

This incentive already existed as part of 2015’s Protecting Americans from Tax Hikes (PATH) Act, but the IRA doubled the available amount. As of January 1, 2023, the amount of the R&D credit that can offset payroll taxes for qualified small businesses doubled from $250,000 to $500,000. To qualify, your business must have less than five years of gross receipts and less than $5 million in gross receipts for the credit year. The additional $250,000 from the IRA can also be used against the employer’s portion of the Medicare tax, and the unused payroll credits will carry forward. Coupled with the IRA’s climate initiatives, the increased R&D credits may incentivize development of clean energy technology, such as carbon capturing and clean hydrogen, by startups and small businesses. If your activities are eligible, these credits could increase your business’s cash savings – so while the filing process may be lengthy, it might also be worthwhile.

Healthcare Reforms

A major provision in the IRA allows Medicare to negotiate prices of certain prescription drugs starting in 2026. The subsidies on healthcare premiums offered by the Affordable Care Act (ACA) are also extended until 2025. In addition, the IRA puts a $2,000 annual cap on out-of-pocket prescription drugs for Medicare users, starting in 2025.

For private business owners, this expanded and more effective coverage through Medicare and the ACA may help reduce the cost of employer-issued insurance plans to employees; however, not everyone is happy about this change.

On June 6, 2023, Merck filed a lawsuit against the federal government on the grounds that the IRA’s drug price negotiation program is unconstitutional, violating the First and Fifth Amendments. The Chamber of Commerce also filed against the IRA on June 9, arguing that it also violates the Eighth Amendment by imposing excessive fines against drugmakers who refuse to negotiate Medicare prices.

As these lawsuits progress, it will be important for private business owners to stay up to date on any developments, as an outcome in Merck and the Chamber of Commerce’s favor could have effects on the cost of employees’ healthcare plans.

Corporate Tax Provisions

The IRA contains several tax provisions that, although largely aimed at benefiting qualifying small businesses, are notable for all private business owners. Along with the clean energy project and R&D-focused tax credits discussed, there is a crackdown on large corporations. Let’s review some of the major tax-related changes as they affect private business owners:

No Change to the Carried Interest ‘Loophole’

Early versions of the IRA included a proposal to close the carried interest loophole found in Section 1061 of the tax code. This allows fund managers to apply the capital gains tax rate rather than the individual income tax rate to their share of profits from deals.

As it stands now, if fund managers hold these portfolio assets for three years, they are taxable at the lower capital gains rate; however, the IRA originally proposed that this holding period be increased to five years – not eliminating the loophole but tightening it significantly. While this proposal was not ultimately included in the IRA, the debate around it remains relevant and is something to monitor.

Increased Funding to the IRS

The IRA provides almost $80 billion in funding for the IRS, with $45.6 billion going toward tax enforcement and the rest toward streamlining and modernizing its operations. This increase in enforcement funding may mean that private business owners are at risk of more audits, as the White House has emphasized it aims to crack down on high-income and high-wealth taxpayers, including large corporations and partnerships.

15% Alternative Minimum Tax (AMT)

Effective January 1, 2023, there will be a 15% AMT for companies with an average annual adjusted financial statement income of more than $1 billion for any three consecutive years preceding the tax year. Exempt from the AMT provision are S corporations, regulated investment companies, and real estate investment trusts.

Those in the private equity industry should note that this new AMT doesn’t include an “expanded aggregation” rule, which means that it won’t apply to unrelated companies that would otherwise meet the $1 billion threshold (if they are owned by an investment fund). The Joint Committee on Taxation (JCT) estimates this provision will raise $222 billion over the next decade.

1% Excise Tax

The IRA imposes a 1% nondeductible excise tax on public company stock buybacks, which the White House says will encourage businesses to invest. This tax applies to publicly traded domestic corporations for repurchases of stock after 2022 and was added to the IRA to replace the revenue lost by removing the carried interest provision. The JCT estimates this excise tax will raise $73.6 billion over 10 years.

Two-Year Extension on Excess Business Loss (EBL) Limitations

As defined by the IRS, an EBL is the amount by which the total deductions attributable to your trade/business exceeds your total gross income from those trades/businesses, plus a threshold amount adjusted for cost of living. The EBL rules were set to expire in 2027, but the IRA extends them until 2029.

Navigating Inflation Reduction Act of 2022 Tax Credits

While these changes may elicit some concern among private business owners, with proper planning opportunities, our Values-Based Wealth Planning team may be able to help those who would otherwise be negatively affected come up with strategies for navigating the IRA’s tax policies.

Overall, as the IRA continues to take effect throughout 2023 and beyond, it is important to be aware of its implications so you can capitalize on opportunities for your business.

If you are interested in discussing your options further reach out to a BBH relationship manager or wealth planner.