3 ways startups are missing out $250,000 of non-dilutive capital (R&D Credits).
Beginning in 2017, the R&D tax credit includes a new way for “qualified small businesses” to receive a credit for their research expenditures by offsetting their payroll taxes.
The R&D Tax Credit has existed for 30+ years, but as an offset to income taxes. Because most startups are in growth mode and have Net Operating Losses, the offset didn’t provide much immediate relief, making the R&D credit largely irrelevant. However, the majority of startups and growth companies have employees, which means they have payroll taxes. The new initiative allows a company to monetize credits to their payroll taxes.
A good way to think about the R&D tax credit is it’s a form of non-dilutive capital (up to a $250,000) that can help your company be more successful.
Here are 3 myths that lead startups to miss out on up to $250k of eligible credits.
Myth #1 — Eligibility
Many people think the R&D is only for companies inventing something new. But it’s also available to companies improving or modifying existing products. They are instances that it can even be applied to internally developed software. The R&D tax credit is designed to encourage innovation in the US economy. This is the reason why it’s available to companies that attempt evolutionary improvements to existing products or processes (most startups fall in this category), but it’s also available for companies that undertake revolutionary activities such as Tesla and SpaceX. In addition, R&D credits can be claimed for any eligible R&D project whether there was a successful outcome or not.
You don’t want to assume your company isn’t eligible, and make a mistake of leaving up to $250k on the table.
Myth #2 — Any accountant can file for R&D credits
Finding a great R&D expert is extremely difficult. R&D Credits is one of the more complicated parts of the tax code, and some fairly heavy-duty expertise is required to understand it.
When picking an R&D provider, make sure they have a large expansive team who understands your industry and that they’ve worked with similar providers in your industry niche. If you are a small equipment manufacturer, then ensure the firm you pick has expertise working with similar clients. Likewise, if you are technology startup, find a provider who has in-depth experience in your niche and industry.
To prevent abuse, the IRS takes a very tough approach to R&D credits filings, especially documentation requirements. It takes some expertise to prepare documentation that can stand up to the IRS’s rigorous methodology; the person preparing the return will have to specifically demonstrate both qualitative and quantitative reasoning. It’s not just about numbers, but an art of connecting the numbers to the big picture story to show how each activity links to specific expenditures. Companies will often mistakenly hire an inexpensive general accountant, who has trouble making a strong case for qualified research.
In addition to finding a good accounting firm. Startups should connect with a PEO and payroll provider such as Justworks to ensure you are working with an IRS payroll provider (need help here)
This is another way you ensure you don’t lose the $250k.
Myth #3 — The R&D tax credit doesn’t help with state taxes.
About 60%+ of states offer some type of R&D credit program. Some states offer credits that can be carried forward while others offer refundable credits. The majority of state eligibility requirements mimic federal eligibility requirements. Some may restrict, include or provide for enhanced credits for certain types of research. The most common differences between federal and state R&D credit computations relate to the credit rate and base amount computations.
This is why it’s important to work with a firm that offers more than R&D tax credit function. The R&D credit is interconnected to other tax issues, and you want to ensure you are working with someone who offers a big picture view of your tax situation.
Even though many companies are eligible for the R&D credit — Only one out of twenty small and medium sized companies eligible companies in the United States take advantage of it. However, given the above myths smaller companies should not be dissuaded from filing it — particularly as the tax credit could be worth up $250,000 per company and up to $10 billion annually to firms.