New IRS Guidelines Increase Payroll Credit for Cannabis Cultivation and Manufacturing Research Activities
The IRS has recently announced a significant change to the qualifying small business payroll credit for increasing research activities, raising the annual cap from $250,000 to $500,000 starting for the 2023 tax year. This update not only increases the potential credit amount but also expands the applicability to include a portion of the company's share of Medicare tax, in addition to Social Security tax.
This is particularly impactful for cannabis cultivation and manufacturing businesses, which often engage in extensive research and development (R&D) to improve their processes and products. Below, we delve into the specifics of this credit and provide examples of Qualified Research Activities (QRA) within the cannabis industry that may qualify for this enhanced credit.
Understanding the Increased Payroll Credit
Key Changes:
1. Increased Cap:
Previous Cap: $250,000
New Cap: $500,000
2. Expanded Applicability:
Previously: Applied only to the employer's share of Social Security tax.
Now: Can be used against a portion of the employer's share of Medicare tax as well.
These changes are designed to encourage more small businesses, including those in the cannabis sector, to invest in R&D by providing substantial tax relief.
Qualified Research Activities in Cannabis Cultivation and Manufacturing
Cannabis businesses, especially those involved in cultivation and manufacturing, often engage in a variety of research activities to optimize their products and processes. Here are some examples of QRAs that cannabis companies have undertaken since 2020:
Environmental Factor Adjustments:
Example: Correcting and optimizing moisture and humidity levels to enhance plant growth and health.
Light Intensity and System Modifications:
Example: Experimenting with different light intensities and systems (e.g., LED vs. HPS) to determine the most effective setup for various cannabis strains.
Cross-Breeding New Strains:
Example: Developing new cannabis strains through cross-breeding to achieve desired traits such as higher THC or CBD content, disease resistance, or faster growth cycles.
Phenotype Hunting:
Example: Identifying and selecting the best phenotypes from new strains to ensure consistent quality and potency.
Substrate and Nutrient Medium Changes:
Example: Experimenting with different substrates (e.g., soil vs. hydroponics) and nutrient mediums to find the optimal combination for plant growth and yield.
Improving Pest and Disease Resistance:
Example: Researching and implementing biological pest control methods or disease-resistant plant varieties to reduce crop losses.
Innovative Harvesting Techniques:
Example: Developing and testing new harvesting methods to improve efficiency and product quality.
Automated Growth Systems:
Example: Implementing and refining automated systems for watering, feeding, and climate control to enhance productivity and consistency.
Maximizing the R&D Credit for Cannabis Businesses
Given the expanded cap and applicability of the R&D payroll credit, cannabis businesses should actively seek to document and claim these credits. The IRS's recent changes are a clear indication of their encouragement for small businesses to leverage these incentives.
Steps to Take:
Identify QRAs:
Assess your business operations to identify all qualifying research activities.
Document Activities:
Keep detailed records of all R&D projects, including objectives, methodologies, and results.
Consult a Cannabis CPA:
Work with a CPA who specializes in cannabis to ensure that you are correctly identifying and documenting QRAs and maximizing your tax benefits.
File Correctly:
Ensure that your tax filings accurately reflect your qualifying expenses and the increased credit.
R&D Tax Credits Are Powerful - Use An Expert!
The IRS's enhancement of the payroll credit for increasing research activities is a significant opportunity for cannabis cultivation and manufacturing businesses. By understanding the scope of QRAs and properly documenting and claiming these credits, cannabis companies can significantly reduce their tax liabilities and reinvest in further research and growth.