By Tanya Donnelly, R&D Tax Manager
You’ve done it! You have taken the leap and started your own company. Maybe it’s a new software program with an innovative AI model, or a new vertically-focused SaaS tool. In the early days, you are busy recruiting engineering talent, pitching potential customers, and trying to raise a Seed round from angel investors and venture capitalists, all while continuing to develop your new product and pay your employees. It is a stressful time, but an exciting one.
What you may not know is that you could be eligible to claim an R&D tax credit and utilize it to offset a portion of your company’s payroll taxes, easing your cash crunch and allowing you to focus your spending on your company’s innovation and development of cutting-edge technology.
Many startup companies may qualify for the Federal Research and Development (R&D) Tax Credit. However, startups did not previously look to claim the R&D credit because they did not have immediate utilization due to the nature of startups generating NOLs for the company’s first few years. Thanks to the Protecting Americans from Tax Hikes (PATH) Act of 2015, enacted on 12/18/2015, Qualified Small Businesses (QSBs) can use the R&D tax credit to offset the employer portion of Federal Insurance Contributions Act (FICA) Social Security payroll tax. This provides a new and extremely beneficial way for startups to utilize the R&D tax credit.
The payroll tax offset has enabled many technology startups to focus more on the company’s R&D activities in various ways, such as maintaining or increasing employee headcount during these challenging times, which in turn could help generate a larger R&D tax credit the next year.
QSBs are businesses with:
- Gross receipts for the tax year of less than $5 million and
- No gross receipts for any tax year preceding the five-tax-year period ending with the credit year.
The payroll tax offset currently allows for a maximum of a $250,000 credit per taxable year, with any unused amounts rolling forward to subsequent payroll quarters. The credit is considered “live” in the quarter after the tax return is filed and must be claimed on an originally filed return, including extension. However, superseding returns are different from amended returns. A superseding return is a return that is filed after the originally filed return but filed within the filing period (including extensions). Superseding returns are considered timely filed returns, so taxpayers that failed to claim R&D tax credits on their originally filed return can file a superseding return and still meet the QSB statutory requirements. For example, if the company filed their 2020 original return on June 30, 2021, and the company had an extension to October 15, 2021, to file, then the company could file a superseding return to claim the R&D credit if the return is filed by the extension deadline of October 15, 2021.
WHO MAY QUALIFY:
While a lot of startup companies hear “Research and Development” and may think only of white lab coats, scientists, and beakers as qualifying activities, the Federal R&D credit is much more expansive. The qualified activities are determined by a 4-part test per IRC 41(d)(1).
- The activities should be technological in nature.
- The activities should be intended to develop or improve the functionality, reliability, performance, or quality of a new or existing business component.
- The activities should be focused on eliminating/addressing technical uncertainties.
- The activities should go through a process of experimentation to eliminate the technical uncertainties.
This means that there are more startups that can qualify for the R&D tax credit, such as software, Saas, FinTech, BioTech, manufacturing, food and beverage, and many more.
WHAT EXPENDITURES MIGHT QUALIFY:
There are four different potential expenditures that may qualify as a part of the R&D Tax credit calculation:
- Contract Research
- Computer Lease/Rental (i.e.: cloud-computing expenditures such as AWS and Azure)
A company was founded in 2019 and looking to claim the 2020 R&D tax credit. The company met the qualified small business criteria. The total wage expenses for the company for 2020 was over $3.5M, of which approximately $3.3M was qualified towards the R&D tax credit. Additionally, the company had qualified supply expenditures over $150,000, non-depreciable in nature and used/consumed during the R&D process. This company’s gross R&D tax credit was over $350,000. With the 280C election, the net Federal R&D credit was over $275,000, with $250,000 applied to the payroll tax offset and over $25,000 placed on the company’s corporate return carry forward statement.
|Total Qualified Expenditures||$3,450,000|
|2020 Gross R&D Tax Credit||2020 Net R&D Tax Credit (280C Election)||Applied to Payroll Tax Offset||Carry Forward|
|Over $350,000||Over $275,000||$250,000||Over $25,000|
If the company is in losses, the company may consider not electing to reduce the R&D credit due to the addback offsetting NOLs, meaning more money would be received now versus later. This creates a great opportunity for tax planning with your accounting team. Additionally, at BRAYN we know how to help you maximize your R&D tax credits and will walk through different strategies with you.
Please email email@example.com today to schedule a no strings attached and risk-free R&D Phase 1 call.
Tanya Donnelly is the R&D Tax Manager of BRAYN Consulting LLC and has a Master’s of Accounting. She is a CPA Candidate, with over 10 years of experience working for the Internal Revenue Service.
BRAYN is a niche consulting firm that guides businesses to greater value through tax credits and incentives. BRAYN Consulting LLC is not a CPA firm, finance, tax, law, or engineering firm, and nothing contained herein can be construed as legal, financial, accounting, tax, or engineering advice.
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