A Short Guide to R&D Tax Credits and How to Take Advantage of Them
As the idiom goes, there are only two things we can be certain are death and taxes. Unless, of course, you’re Donald Trump, a man who somehow managed to beat COVID-19 in under a week and only pay $750 in Federal Income tax in 2017. While his miraculous full recovery is improbable, we do know he certainly applied some questionable interpretations of the US Tax Code to receive sizable deductions and credits. For a startup company strapped with expenses and continuously working toward profitability, knowing that you likely paid more than a self-proclaimed billionaire in Federal Income Tax is a common frustration. In light of these frustrations, I wanted to share an essential tool for tech startups to obtain tax credits; Research & Experimentation Tax Credit (R&D). While I can’t promise that R&D Tax Credits can bring your taxes down to $750, they still offer a legal way to obtain significant returns.
What are R&D Tax Credits?
In December of 2015, the Protecting Americans from Tax Hikes (PATH) Act made permanent the R&D credit. R&D credits are a general business tax credit available to companies that incur R&D costs within the United States. Specifically, PATH gives startups the ability to utilize these tax credits if they are engaged in:
- Continuous manufacturing, research, or engineering of new processes and products;
- Designing and developing product alternatives and more efficient designs;
- Improving techniques, formulas, inventions, and software; or
- Employing engineers, scientists, software programmers, etc.
R&D tax credits are calculated based on increases in research activities and expenditures and are intended to reward companies that pursue innovation with increasing investment. So, if you are a startup looking to innovate (which you almost certainly are), then R&D tax credits are your opportunity to recoup some of your capital and invest it back into your company.
How Are These Credits Applied?
R&D Tax Credits can be applied to any qualified R&D expense. Of these qualified expenses, both in-house and subcontracted wages and supplies tend to be the most utilized by startups (and can also be the most lucrative for returns). If you have less than $50 million in gross receipts and have one or more of these qualified expenses, PATH will provide R&D Tax Credits against your alternative minimum tax (AMT). Further, if your startup is within its first five years of operation and is receiving less than $5 million in revenue, you may also be able to receive R&D Tax credits for payroll tax liability (with an annual cap at $250,000).
How Do I Maximize my R&D Tax Credits?
If you’re reading this and realizing that you could have been claiming these all along, there’s still hope for those missed credits. PATH allows claims to be made retroactively for up to three years. Further, R&D tax credits are typically not something that your average CPA will take into account. Ask your accountant if they have, in fact, utilized these credits for you in the past and how you can maximize these returns in the future.
R&D Tax Credit Services
If you are in the early stages of developing your product or currently do your startup’s taxes, then I have some bad news for you. The process of claiming these tax credits is needlessly lengthy and difficult. However, several companies specialize in R&D tax credits that you can take advantage of for only a small fee. For both Federal and State R&D Tax Credits, specialized R&D Tax Credit companies will typically take ~20% of your return for rendering service; however, this may be worthwhile to save yourself the time and the headaches associated with the process. Some of the most popular companies in the United States include Neo.tax, Mainstreet, and Tax Taker.
Beyond the US
If you are currently operating outside of the United States, there is still a chance that you can take advantage of similar systems to the PATH Act. In the UK, for example, R&D tax credits are also available for tech startups. The app-based service Claimer is similar to Mainstreet in the US and only takes 5% of your return for service fees.
Additionally, in Canada, R&D tax credits are known as SRED tax credits. Unlike the US R&D Credit, SRED credits require that there is uncertainty about whether the project will work or not. This uncertainty must be about if the development you are undergoing will create a functioning prototype that achieves your goals and cannot be merely uncertainty about your startup’s market and reception. Boast, an app-based SRED credit company is considered one of the most popular equivalents to Neo.tax or Mainstreet.
While the use of the R&D Tax Credit isn’t going to reduce millions of dollars of taxes down to $750, they can nonetheless be an incredibly valuable tool for tech startups looking to maintain capital and reinvest in their innovation. Even if taxes are certain (and I can promise you the IRS will make sure that stays true), you certainly don’t have to be paying as much as you do now if you aren’t currently using your R&D Tax Credits.
Read more from Law4Startups