If you spend time on research and development, recent changes to the tax law could give you a big break on your payroll taxes — up to $250,000 a year. That cash could make or break a startup, where cash is king. We helped our clients save approximately $10 million with the R&D tax credit on 2016 returns.
R&D Tax Credits
Tax credits give you discounts on federal and state taxes, if you satisfy all of the qualifications. (Not all states have a credit, so check your state’s laws.)
The R&D tax credit has been around since 1981, applying only to income tax, until recently. Starting in the 2016 tax year, the R&D tax credit can be used to offset payroll tax for qualifying startup companies. Previously, the credit was only allowed to offset income tax, which most startups don’t pay. Now, early-stage companies who haven’t been profitable don’t have to miss out; they can claim the credit too. These changes provide substantial competitive advantages and growth opportunities via tax savings and cash flow. Previously these options were utilized almost exclusively by Fortune 500 firms. These larger firms have received billions in credits annually over the last thirty years. Now startups can access those same credits.
On average, the credit equals 6-10% of a company’s R&D cost, including but not limited to wages, supplies and even contract researchers. The maximum cap annually is $250,000, which means your company could save $1.25 million over five years.
Does My Company Qualify?
To receive the R&D tax credit, your company must:
- Have $5 million or less in annualized gross receipts (that includes companies with no declarable income yet)
- Have five or fewer years of gross receipts
- Have its R&D evaluated and determined valid
Be prepared to devote some time and resources to the testing process. Getting your R&D evaluated and approved is a four-part process. Each part has extensive regulations and intensive documentation:
- Technical uncertainty: What’s being made new or improved?
- A process of experimentation: Were alternatives explored? Was modeling done?
- Technological in nature: Are you using hard sciences?
- Qualified purpose: Are you making or improving a product as it relates to performance, ability, function or quality? (One caveat: Software and other similar developments that are for internal use only don’t qualify; the work must benefit the public.)
The fields for R&D are varied and popular, and many startups will qualify, especially those in app development, platform design, cryptocurrency, robotics, VR hardware and software, drones and wearables. (A clarifying note: A company that was founded before 2012 can still qualify if it did not generate any gross receipts. For example, a research-intensive firm might have existed for years before generating receipts.)
Using this credit will probably increase the chance of an audit, so make sure you enlist a qualified tax advisor to claim this credit correctly. After your company qualifies for the R&D validation, claim the credit on the annual income tax return, then monetize the credit on subsequent quarterly payroll tax returns. Even factoring in any potential risk, there is a strong positive outlook on the total gains to be had. Firms who think they have eligible activity or want to develop activity as a result of the incentive should move soon to best fully capture the returns possible.
A version of this post originally appeared here.