R&D Tax Credit can help your startup claim tax benefits that may provide immediate and significant cash savings.
Under the Internal Revenue Code Section 41, the R&D Tax Credit is a general business tax credit for companies that invest in scientific and technological development activities in the US. Since its introduction in 1981, many companies received significant dollar-for-dollar reduction of their federal (and state, if applicable) income tax liability. On December 18, 2015, the US Congress has expanded the R&D Tax Credit benefit by allowing certain small businesses regardless of company's financial status. This change provides startups with an opportunity to claim R&D Tax Benefits for innovative products and services being built and marketed by the company.
R&D defined in Sec. 41 is much broader than the traditional concept of R&D (e.g., scientists in lab coats working in clean-room laboratories). Many companies in various industries are unaware of their eligibility that their daily activities could qualify for this benefit.
Examples of potentially qualifying R&D activities
- Software company developing application to manage large scale data and process them online to provide 'near-realtime' customer recommendations.
- Hardware company developing a new IoT device to detect and eliminate harmful substances in nearby environments.
- Manufacturing product line changes to significantly improve throughput and/or quality.
- Biotech / Pharmaceutical company using artificial intelligence to diagnose patient's symptoms and customize the dosage levels.
To be considered as qualified R&D activity, the activity must meet each of the following 'Four Part Test'.
|The 'Four Part Test'|
|Permitted Purpose||The activity must relate to a new and/or improved business component, in respect to its function, performance, reliability, and/or quality.|
|Technological in Nature||The activity performed must fundamentally rely on the principle of physical, biological, computer science, or engineering.|
|Elimination of Uncertainty||The activity must be intended to discover information to eliminate uncertainty concerning the capability, design, function, and/or methods for developing and/or improving a business component.|
|Process of Elimination||The taxpayer must engage in an evaluative process (e.g., simulation, experiments, trial-and-error) that is capable of identifying and evaluating one or more alternatives to achieve a result.|
For some products and processes built for internal-use (e.g., custom CRM system used within the company), additional qualification requirements exist.
Startups qualified for R&D Tax Credit can apply the benefits to offset either payroll tax, AMT, or corporate income tax, based on the company's circumstances. The R&D Tax Credit can generate immediate cash savings that can be reinvested to the R&D activity, or to other business operations.
|R&D Tax Credit used to offset||High-level requirements
|Most likely to be applicable for|
|FICA payroll tax||<$5M in gross receipts||Early-stage startups (even operating at a loss)|
|Alternative minimum tax (AMT)||<$50M in past 3-year average gross receipt||Mid-stage startups|
|Corporate income tax||All other scenarios||Late-stage startups and larger companies|
Even in cases where a startup cannot immediately utilize the benefit, R&D Tax Credit can be filed as a 'carry-forward credit' in the tax return that can be used to offset liabilities in the future. In addition to generating benefit for future use, this also cues a positive signal about the startup's innovation capability that can further attract potential buyers and/or investors.
While R&D Tax Credit can be an extremely beneficial tax incentive for a startup, it requires navigating through a complex credit calculation process including assessment of QRE (Qualified Research Expense) and base calculation, as well as thorough and meticulous documentation supporting the claimed credit and the associated R&D activities, which is a burden of proof to the company. As such, many startups choose to work with highly qualified professionals with expertise in R&D Tax Credit to maximize the firm's benefit potential while being fully compliant and audit-ready.
Our dedicated team at Pinecone41 has deep expertise in R&D Tax Credit, and have helped many clients benefit from it. Contact us to discuss further how we can help your company.
* Please note that the information presented on this page are to be regarded as general information, and should not be interpreted as tax, financial, or legal advice.