Startups, Profitability, and R&D Tax Credits
Getting started with your small business or startup can certainly be an anxiety-inducing venture. In general, startups face high uncertainty and, sadly, have high rates of failure. The most successful entrepreneurs take advantage of every available opportunity afforded them. One such opportunity that gives small businesses and startups a competitive advantage is the R&D tax credits program. Your small business or startup, that is not showing a profit, may qualify for the R&D tax credit. Companies don’t need revenue to claim the credit and don’t need to be paying income tax. The credit can be taken as a payroll tax offset, up to $250K per year, by qualified small businesses. You are considered a qualified small business if you have less than $5 million in revenue and are within five years of your first gross receipt. The best way for your small business to learn more about the R&D tax credit program and their R&D tax credit eligibility is to work with an experienced and well-qualified R&D tax credit consultant. Schedule a free consultation with Clarus R+D to learn more about R&D tax credits and find out if your small business or startup is eligible to claim the credit. Clarus’ technology-driven solution empowers companies to fuel their growth with America’s largest tax incentive.
The R&D tax credit for small businesses and startups: profitability
Despite its well-established and successful history, countless eligible companies fail to claim the research and development tax credit every year. This is especially true for owners of small businesses and startups. Small businesses and startups may be eligible to apply up to $1.25 million—or $250,000 each year for up to five years—of the federal R&D credit to offset the Federal Insurance Contributions Act (FICA) portion of their payroll taxes each year. To be eligible, a company must meet two requirements:
- Have less than $5 million in gross receipts for the credit year
- Have no more than five years of gross receipts
Those taxpayers, however, might fail to consider their eligibility for the R&D tax credit program for any number of reasons. Still, many startups don’t understand they’re eligible to claim the R&D tax credit and continue to miss out on money they’ve already earned. At Clarus R+D, we talk to entrepreneurs every day, and we’ve heard it all. Here are some of the reasons startups miss this non-dilutive funding opportunity.
Some entrepreneurs assume the program sounds too good to be true and, therefore, complicated. At Clarus R+D, we work with small- to mid-sized business owners to discuss the eligibility requirements, explain the benefits of the tax credit program, and offer solutions to maximize the credit.
The business has not produced any revenue
Once again, companies don’t have to demonstrate income (or pay income taxes) to qualify for the credit. Qualifying smaller companies and startups can take the benefit as a payroll tax offset, claiming up to $250,000 every year. This applies to small businesses showing less than $5 million in the credit year, with no gross receipts in the previous five years.
The business does not have any employees
Sure, using the credit to offset payroll taxes does make it seem as if you’d have to have employees to pay. While wages generally contribute most heavily to the final credit calculation, other costs, like supply expenses and contractor payments, are also eligible. Most importantly, if you do take the research and development credit as a payroll tax offset without actual payroll, you can carry the credit forward for up to 20 years.
The business doesn’t do research
This is, perhaps, the greatest misconception about R&D tax credit eligibility. You needn’t be in the business of operating a research laboratory to be eligible for the research and development credit. You don’t have to employ a team of scientists running around in lab coats either. At Clarus R+D, we partner with entrepreneurs across all industries.
The business is not successful
A business does not have to be successful to qualify for the benefit. Riskier initiatives often fail with no return on investment. Recognizing that, the federal government provides incentives like the R&D credit to lessen the burden. Consequently, you will be rewarded for facing technical challenges and pushing forward on innovative solutions. These technological breakthroughs are all part of the research and development terrain. Even if the work isn’t successful, the effort itself (and the costs associated with it) may make your business eligible to receive the credit.
Business does research but not developing anything new
The R&D tax credit is for taxpayers that design, develop, or improve products, processes, techniques, formulas, or software. It’s calculated on the basis of increases in research activities and expenditures—and as a result, it’s intended to reward companies that pursue innovation with increasing investment. R&D doesn’t have to be new to the industry. It simply needs to be new to the company, which must have activities that meet the four-part IRS test below. Read more to learn why small businesses and startups miss out on the R&D tax credit. Clarus R+D will work with you to help you understand what is considered qualified research for purposes of determining R&D tax credit eligibility.
Myths about R&D tax credits and profits for startups
Every year, eligible businesses don’t avail themselves of the benefits of the R&D tax credit. IRS statistics show that R&D tax credits worth over $12 billion were claimed in 2014, the latest year for which data is available. While this sounds significant, a large number of eligible entities, especially small businesses and startups with no shown profit, neglect to claim the R&D credit. One of the biggest drivers for the underutilization is likely a lack of knowledge by both taxpayers and their advisers. Many are unaware of the R&D tax credit or otherwise believe their business activities are not eligible. Some of the common myths about R&D tax credits for startups and small businesses include:
I don’t qualify. Many businesses perform activities that qualify for the R&D tax credit without realizing it. The R&D tax credit can be used by companies of any size in industries ranging from software development to breweries. If you do anything technology-based, improve it, and sell it to customers, you probably qualify.
It can only be applied to income tax. This is not true. The credit can be taken as a payroll tax offset, up to $250K per year, by qualified small businesses. You are considered a qualified small business if you have less than $5 million in revenue and are within five years of your first gross receipt. If you have no payroll, the credit can be carried forward to the next quarterly return. The credit doesn’t expire and continues to be available until it can be fully used against payroll tax. Unused credits can also be useful upon exit.
The savings aren’t worth it. Are you kidding? We have many examples of companies saving tens and even hundreds of thousands of dollars with the R&D tax credit. Remember, this is a credit, not a deduction. It’s applied directly against taxes owed. Plus, our technology-driven solution simplifies the process of claiming the credit and reduces overall fees.
Clarus R+D can help provide clarification on the applicability of the research and development credit, walk you and your small business or startup team through a study and calculation, and can be there to support you in times of an audit.
R&D tax credit expansion benefits startups without profit
For years, the R&D tax credit was truly unavailable to those businesses for whom it was initially designed – innovative startups. In that the majority of startups are not immediately profitable and thus pay no federal income taxes, it was counterintuitive that our nation’s most cutting-edge companies were essentially barred from a tax incentive because they were not profitable. An important amendment—the startup provision—changed everything for startups. Beginning in 2016, startups were able to claim the credit, capped at $250,000, annually, against certain payroll taxes. This amendment was truly a game-changer for innovative entrepreneurs and their startups.
Impact on Tax Advisors
The consequences of the amended R&D tax credit language are vast. Needless to say, this was the most significant tax legislation for the startups and their tax advisors in years. Given the breadth of the amendment, taxpayers across all industries may be eligible for a tax incentive that could make the difference between their startup surviving or not. In order to position your startup for success, it is important to work with an experienced R&D tax credit advisor who has helped other startups claim R&D tax credits. Clarus R+D specializes in working with innovative startups to help them determine their eligibility and claim their R&D tax credits.
R&D tax credit eligibility for startups
Working with a professional R&D tax credit consultant, like Clarus R+D, is the best way for you to determine your startup’s tax credit eligibility. In order to be eligible for the research and development tax credit, your startup or small business must engage in qualified research. Qualified research generally is private sector or commercially driven development intended to yield innovation within a scientific or technological field. The following four-part test determines whether an activity is considered qualified research and, thus, eligible for the R&D tax credit.
The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component. A business component is defined as any product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.
Elimination of Uncertainty
The taxpayer must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development or improvement, or the appropriateness of the business component’s design.
Process of Experimentation
The taxpayer must undergo a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer’s research activities. Treasury Regulations define this as broadly as conventional implementation of the scientific method to something as informal as systematic trial and error process.
Technological in Nature
The process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement. Research activities that qualify for R&D tax credits must be conducted in the U.S. If your business does any of the following, it likely qualifies for the R&D tax credit:
- Develops or designs new products or processes
- Enhances existing products or processes
- Develops or improves upon existing prototypes and software
Even if your work passes the four-part test, there are a few exclusions to the R&D tax credit. Expenses incurred under the exclusions will not qualify for the incentive. Some of these already appear in the four-part test, including the need to rely on hard sciences. The activity must take place in the U.S. and cannot include routine data collection or market research. Also, activities cannot receive funding from an unrelated third party because your company might not retain ownership of the resulting intellectual property. Clarus R+D will work with you to help you understand what is considered qualified research for purposes of determining R&D tax credit eligibility.
Internal Use Software
If research and development is related to internal-use software for your business, it must meet these criteria:
- Be innovative
- Result in an economically significant reduction in cost or improvement in speed
- Involve economic risk to develop
- Not be commercially available
R&D tax credit startup activities and industries
With the expansion of the research and development tax credit over the years, more businesses than ever before engage in activities making them eligible to claim the R&D tax credit. If you are uncertain if your business activities qualify, contact a professional R&D tax credit advisor, like Clarus R+D, who can help. In the meantime, listed below are examples of activities that may be considered qualifying research activities:
- Conduct testing of new concepts and technology
- Develop prototypes and models
- Develop new, improved, or more reliable products, processes, or formulas
- Develop or apply for patents
- Add equipment that improves a process
- Streamline your manufacturing process
- Develop new software
- Design for LEED/green initiatives
- Conduct environmental testing
- HVAC concept and design
- Searching for ways to apply new research findings
- Designing product alternatives
- Conducting system and functional requirements analysis
- Utilizing integration analysis
- Conducting research aimed to significantly cut a product’s time-to-market
- Conducting research aimed to obtain more efficient designs
- Developing and modifying research methods / formulations / products
- Paying outside consultants / contractors to do any of the above activities
More traditional scientific work, like one might imagine in pharmaceutical product development, is naturally considered qualified research. What about work in other industries? A list follows that provides examples of various industries that often engage in R&D tax credit eligible work.
- Consumer products
- Medical devices
- Software development
- Food & Beverage
R&D tax credit advisors for startups: What to expect
Working with a professional R&D tax credit advisor is the best way to determine eligibility and maximize your benefit. Here is what you can expect by selecting Clarus R+D as your R&D tax credit consultants:
- Clarus R+D provides a team of professionals with expert credentials able to answer all your R&D tax credit questions.
- Our proprietary software streamlines R&D studies which maximizes your ROI.
- Clarus has expert knowledge of the IRS regulations relating to the research and development tax credit, IRC Section 41, as well as the regulations pertaining to state-specific research and development credits.
- Clarus has extensive experience in recognizing qualified research activities and expenditures.
- Our time-proven methodology has yielded maximum benefits to our clients.
- The Clarus team has helped hundreds of clients claim millions in R&D tax credits.
- We place emphasis on helping growth businesses take advantage of the tax incentive.
- Clarus does the work for you; our web-based app allows you to enter information at your own pace.
- We have extensive IRS and state audit experience and provide our clients with audit support.
- We have maintained an exceptional success rate in applying for the R&D tax credit.
- We work directly with our clients and their respective accounting firm and payroll processor.
- Our process saves valuable time and resources within the engineering and finance departments.
- Our fees are very competitive.
- Our performance, success rate, and unparalleled quality of service result in high client loyalty.
Ready to get started?
Schedule a free consultation with our team of experts to learn more. We’ll discuss the R&D tax credit and help you determine if our solution is a fit for your company.
ABOUT CLARUS R+DWith custom software backed by a team of tax experts, Clarus R+D specializes in tax credits for growth businesses. Our technology-driven solution simplifies the process, maximizes benefit, and ensures compliance. We partner with accounting firms, financial advisors, investors, payroll providers, and more.