How well does IRS identify ineligible businesses that claim the Payroll Tax Credit?

Controls for the Qualified Small Business Payroll Tax Credit Were Updated, but Ineligible Taxpayers Continue to Receive the Credit   Why did we do this audit? The Protecting Americans from Tax Hikes Act allowed a qualified small business to use up to $250,000 of the Research Credit as a payroll tax credit to offset the employer’s portion of Social Security tax (Payroll Tax Credit). Subsequently, the Inflation Reduction Act of 2022 increased the amount of the Qualified Small Business Payroll Tax Credit from $250,000 to $500,000. In addition, a qualified small business may apply up to $250,000 of any excess credit against the Medicare tax on wages paid starting with Tax Year 2023. For example, if an employer’s Payroll Tax Credit exceeds the Social Security tax, the employer can apply the excess against Medicare tax up to $250,000. In December 2018, we reported that the IRS did not have processes to identify small businesses that were not eligible for the Payroll Tax Credit. This audit is a follow-up to that review.  What did we find? As of June 2025, the IRS received approximately: 11,400 Forms 941, Employer’s QUARTERLY Federal Tax Return, with $382 million in Qualified Small Business Payroll Tax Credit for Tax Year 2023. 12,600 Forms 941 with $381 million in Qualified Small Business Payroll Tax Credit for Tax Year 2024. Qualified small businesses can carry unused credits forward to subsequent quarters indefinitely, until the credit is fully claimed. Generally, taxpayers use Form 8974, Qualified Small Business Payroll Tax Credit for Increasing Research Activities, to claim the Payroll Tax Credit. The IRS uses business rules to check the accuracy of fields and calculations on electronically filed Forms 8974 before tax returns are accepted for processing. The IRS implemented actions to address previous concerns we reported about three Form 8974 business rules. Additionally, the IRS took action to address business rule errors brought to their attention by taxpayers that prevented them from reporting the maximum allowed credit. However, the IRS still does not have processes to address ineligible taxpayers who claim the Qualified Small Business Payroll Tax Credit. Qualified small businesses must make an election on Section D of Form 6765, Credit for Increasing Research Activities, to use the Research Credit to offset payroll taxes. Analysis of business tax returns electronically filed as of December 2024 found that 40 businesses with a Form 6765 election for Tax Year 2023 did not meet the gross receipts eligibility requirement. The IRS erroneously allowed these businesses to claim $3.1 million in Research Credits to offset Tax Years 2023 and 2024 payroll taxes.   Read the full report Having trouble viewing this email? View it as a Web page.

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