Ineligible businesses getting payroll tax credits

Small businesses that don’t qualify for a payroll tax break are still claiming and receiving it, despite the Internal Revenue Service’s efforts to stop them, according to a new report.

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The report, released Monday by the Treasury Inspector General for Tax Administration, found 40 ineligible businesses claimed the Qualified Small Business Payroll Tax Credit  for 2023, but the IRS pointed out that was less than 1% of the total number of returns reviewed by TIGTA. The Protecting Americans from Tax Hikes Act of 2015, also known as the PATH 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. The Inflation Reduction Act of 2022 later increased the amount of the Qualified Small Business Payroll Tax Credit from $250,000 to $500,000.

A qualified small business can apply up to $250,000 of any excess credit against the Medicare tax on wages paid starting in tax year 2023. Thus, 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, TIGTA reported that the IRS didn’t have processes to identify small businesses that were not eligible for the payroll tax credit. The new report followed up on that earlier report and found that despite the new controls put in place by the IRS, some of the credits were still slipping through the cracks.

As of June 2025, the IRS received approximately 11,400 Forms 941 with $382 million in Qualified Small Business Payroll Tax Credit for 2023, and 12,600 for 2024.

Qualified small businesses can carryforward their unused credits 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 various business rules to check on the accuracy of fields and calculations on electronically filed Forms 8974 before it accepts the tax returns for processing. The IRS took action to address TIGTA’s previous concerns about three Form 8974 business rules, along with business rule errors brought to the IRS’s attention by taxpayers that prevented them from reporting the maximum allowed credit.

However, the IRS still doesn’t have processes in place to address ineligible taxpayers who claim the Qualified Small Business Payroll Tax Credit, according to the report. Qualified small businesses have to make an election on Section D of Form 6765, Credit for Increasing Research Activities, to use the research credit to offset their payroll taxes. TIGTA’s analysis of business tax returns electronically filed as of December 2024 found that 40 businesses with a Form 6765 election for tax year 2023 didn’t meet the gross receipts eligibility requirement. The IRS nevertheless allowed these businesses to claim $3.1 million in research credits to offset tax years 2023 and 2024 payroll taxes.

“While most businesses that claim the Payroll Tax Credit are eligible, incorrect claims can have far-reaching effects,” said the report. “For example, the payroll taxes that businesses are required to pay help fund programs such as Social Security and Medicare. As a result, erroneous credits reduce the funding paid to these programs.”

TIGTA recommended that the IRS review the 40 ineligible businesses that we identified and recover any erroneously claimed Qualified Small Business Payroll Tax Credit. The IRS agreed and said it would review those cases and determine what action is appropriate.

“We recognize that payroll taxes support the Social Security and Medicare trust funds and remain committed to safeguarding the integrity of the credit while providing timely service to ineligible taxpayers,” wrote Lia Colbert, commissioner of the IRS’s Small Business/Self-Employed division, in response to the partially redacted report.

However, she pointed out that there were only a “limited number of cases” where the ineligible credits slipped through the IRS’s controls. “As your report notes, of approximately 7,300 Tax Year 2023 e-filed business returns that included a Form 6765 election, 40 were identified as not meeting the gross receipts eligibility requirement — approximately one-half of one percent of the population reviewed.”