Startup R&D tax credits are one of the most important tax credits available to VC-backed startups, so Kruze Consulting has created a simple Startup R&D Tax Credit Calculator to show Founders how much they can save. Traditionally, these tax credits were calculated and saved up against a corporation’s annual tax forms. For startups that aren’t yet profitable, that meant that they would only benefit from these tax credits once they became profitable in future years.
The PATH (Protecting Americans from Tax Hikes) Act of 2015 has changed all of that. Regulators acknowledged that the old R&D tax credits weren’t appetizing to founders if it only promised a potential future benefit that may never be realized. And so the R&D tax credit has been revised to give more instant gratification: R&D tax credits generated in 2021 can be used to offset payroll taxes come 2022.
Prior to the PATH update, I sometimes told my clients that the cost of performing an R&D tax credit study would outweigh the benefit. Now that you can claim these credits almost immediately and against your payroll taxes, I highly recommend that every eligible startup engage in an R&D Tax Credit payroll offset.
Do I need a CPA to help me with this credit?
Yes, we highly recommend you work with the same CPA who does your corporation’s tax returns - this is part of the tax return. And if you are a VC-backed company, it’s the part of your return that’s most likely to generate an audit. We’ve supported multiple companies through IRS audits, and have trained our team on how to properly document the work.
Secondly, the IRS isn’t the only group that will want to examine your tax returns and credit documentation. Our clients raise over $1B per year in VC funding, and at the later stage it’s becoming increasingly common for investors to hire Big Four accounting firms to diligence the books and tax returns. That’s why having a CPA on call, like us, is helpful - founders don’t need the added stress of coordinating and checking tax diligence during a major transaction. We are experts at helping startups with their diligence and are already know what questions the Big Four partners are likely to ask you during diligence.
Why should I have my startup file for the R&D tax credit payroll offset?
IT SAVES YOU DIRECT $$$ NOW!!!
Up to $250,000 per year for up to 5 years! And Congress has this increasing up to half a million per year starting for the tax year 2023.
Am I eligible? Can any startup apply for the R&D tax credit payroll offset? What defines Research & Development?
Unfortunately, not every company is eligible. You must be creating something new, and by new I mean pass the IRS’ 4 Part Test. Your R&D must be:
- Specific: no mindless tinkering allowed. The project must be defined.
- Eliminate Uncertainty: must be contributing real scientific advancement, not just proving existing knowledge.
- Experimental: either have a scientific method or trial and error process.
- Technical: the work must be grounded in the hard sciences like biology or engineering.
Are there any R&D activities that don’t qualify?
- Research after commercial production
- Adaptation of existing business components
- Duplication of existing business component
- Reverse Engineering
- Surveys & studies
- Computer software for internal use
- Foreign research
- Research in the Social Sciences, Arts, Humanities, etc.
- Funded research
Is my startup eligible for the R&D tax credit payroll offset?
- The startup must have qualifying R&D expenses (see definition below).
- The startup must be new; only startups that have generated revenue for 5 years or less can claim the new tax credit. If you had receipts prior to 2017, then you’re ineligible.
- To be a qualified small business, an eligible startup must have less than $5 million in gross receipts over a five-year period and no gross receipts before the five-year period ending with the tax year.
What qualifies as a R&D Expense? What goes into the calculation?
- Wages: but only for those people who engage in R&D activities.
- Subcontractors engaged in R&D: ‘nuff said.
- Supplies: only include direct supplies that were related to the R&D project and weren’t classified as an asset.
- Computer Leases/Rentals: we rarely see this…
It’s very important to note that the credit is not just payroll, which is why it’s good to work with the accounting team that does your bookkeeping. They can help make sure you get the credit for expenses that don’t run through your payroll provider.
How do I claim the R&D tax credit payroll offset?
First file the R&D tax credit on Form 6765 (Credit for Increasing Research Activities) which is a part of your 2021 annual corporate form 1120 (US Corporation Income Tax Return). Then claim your R&D tax credit on payroll tax form 941 (Employer’s Quarterly Federal Tax Return); you’ll need to work with your payroll processor to make this happen. We love working with Gusto, but just about every major payroll processor should be able to help.
When should I file the R&D tax credit payroll offset?
In early 2022, after you’ve closed out your 2021 books. Work with your CPA on an R&D tax credit study: once you’ve determined what your tax credit will be, add it to your 2021 annual corporate form 1120 and file the return. In the quarter following your 1120 filing, you can start applying those tax credits to your payroll taxes. For example, if you file your 2021 Form 1120 corporation tax return by March 15th, 2022 and meet the criteria of a qualifying small business, you would be able to file a payroll tax credit with your Q2 2022 Form 941 payroll tax return.
How much will my startup really save by implementing the startup R&D tax credit payroll offset?
~10% of eligible R&D costs, up to $250,000 per year, for 5 years. And again, the Inflation Reduction Act of 2022 will double the maximum amount, but not until the tax year 2023.
Caveat: this article is intended as general guidance for startups and it doesn’t substitute the need to work with a professional. It’s also a high level overview and is in no way complete. Your company is unique; talk to your CPA.
