The Inflation Reduction Act of 2022, passed August 12, 2022, increases the R&D Tax Credit amount from $250,000 to $500,000.
Estimate your R&D tax credit using our free calculator
The IRS has a startup R&D tax credit that allows unprofitable startups to decrease their payroll tax liabilities by up to $250,000 per year - increasing to $500,000 after the passage of the Inflation Reduction Act. The tax credit is available to startups that conduct qualified R&D activities within the United States. Kruze clients save over $10M per year using this credit.
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There are several important points for startup founders to know about R&D tax credits, how they are calculated and how to claim them.
The Kruze Consulting R&D Tax Credit Calculator is designed to estimate your R&D tax credit using Federal Form 6765.
Let Kruze Consulting handle your startup’s R&D Tax Credit analysis and preparation. We charge a fixed fee of 1.5% of the anticipated qualifying expenses with a minimum fee of $1,000. Our clients are saving over $10 million per year!
Congress passed the Inflation Reduction Act of 2022 on August 12, 2022, and the President signed it the following week. This act doubles the possible R&D tax credit that a startup can get to half a million dollars.
We analyzed over 625 startup tax returns and noted that only 2.5% of startups would be eligible for over $250,000 in credits. Of course, this is still a great incentive that startups should take advantage of to reduce their burn rate!
Starting in 2022, the IRS is requiring additional documentation from startups that are claiming research and development tax credits. The new requirements include providing more information about the startup’s R&D claim.
Startups will need to identify:
If the IRS rejects your claim, you may not have the opportunity to “perfect” your claim and you may lose R&D tax credits. It’s important for you to review these requirements with an R&D tax professional so you document them properly.
Caveat: The information on this page intended as general guidance 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; contact Kruze Consulting.
First, what is an R&D tax credit? When you spend a lot of money on true R&D, your engineers are building something unique and novel, you can capture a small percentage, about 5 or 10%, of that spend into credit. Today’s R&D tax credit can be used to offset payroll costs that even unprofitable startups incur, although this was not always the case (read on to learn more about the history of the incentive). It’s a nice policy designed to encourage companies to spend money on R&D and move the ball forward in technology.
In the past, R&D tax credits were not able to be used immediately. R&D tax credits have been around for a long time, but in the past, you could do an R&D tax credit, but you couldn’t use it until you were profitable. For most startups, they don’t hit profitability until about five to ten years in. Or they may even be acquired before hitting profitability. It became this thing where it’s a low ROI thing for startups. The feeling was, “why would I spend precious dollars now for some benefit that I’ll maybe get 5 to 10 years from now?” Because of this, many companies either did a placeholder or they just wouldn’t file it.
A few years ago, the tax policy changed. Congress, the Treasury, and the IRS got together a few years ago and said, “how can we incentivize more R&D expenditures in our economy?” What they realized was that startups, one of the biggest innovation engines in the economy, were not taking advantage of the R&D tax credit. They realized they needed to make it more applicable and ROI-positive for them immediately. Once they looked around and they realized that pretty much every startup that was doing R&D was paying payroll taxes, they realized they could let startups apply for the credit against their payroll taxes, and that made them ROI positive immediately. Use the Kruze R&D tax credit calculator to estimate how much money your startup could save using this valuable incentive. Kruze has helped hundreds of companies save millions of dollars - this year our clients are collectively saving over $10 million. Take advantage of this government program!
It saves You direct $$$ NOW!!! The Treasury actually sends a check, or your payroll provider decreases your payroll taxes, so you save money now. For the year ended 2021, you can save up to $250,000, and for the tax year 2023 the amount is increased to $500,000!
Use our R&D tax credit calculator - above - to estimate how much of this valuable government incentive your startup can get.
Section 382 is a part of the IRS code that the IRS created 20 or 30 years ago to try to limit how corporations could use their net operating losses to reduce their profits.
This is a difficult calculation, and we do not recommend you try to do a Section 382 calculation on your own. And startups really ought to work with a CPA who knows early-stage businesses, because part of the calculation involves looking at your company’s capitalization table. Unless your accountant works with venture-backed companies, they are going to have problems applying Section 382 to your VC backed cap table!
At a high level, there are 3 items or “triggers” to Section 382.
If you become profitable. You are going to want to start using your Net Operating Losses (NOLs) - so contact us or a CPA who knows early-stage companies.
If you are getting acquired. If a big company is buying your business, they are going to want to use those NOLs, and those NOLs have real value. You are going to want to capture those, so again, get a good accountant to help you. On average one to three of our clients are acquired each and every month, so we know how to negotiate with public company tax teams!
If you are liquidating some of your assets, you probably have valuable NOLs.
Watch the video to learn more.
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:
Yes. Here are a few:
Your startup must have qualifying R&D expenses (see definition below). Your business 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 2012, then you’re ineligible. Your company must have less than $5 million in revenue in 2018 and each subsequent year that you claim the payroll offset.
What goes into the calculation of an R&D expense, for the tax credit calculation purposes? And the answer is there are four main categories.
The first of which is wages. And this is where you’re going to capture a lot of your value. But keep in mind you can only do this for people who are engaged in R&D type activities. So usually this is your engineers.
Next up are your subcontractors. But again, only those are engaged in R&D and only the ones that are domestic.
Next up we have supplies, this is your nuts bolts all of the hardware that kind of goes into whatever you’re developing. You can absolutely include that in the R&D tax credit study.
Last but not least, but we rarely see this computer leases and rentals.
Follow these steps:
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 Form 1120 by March 15th, the first payroll tax offset you would receive is for Q2 2022.
~10% of eligible R&D costs, up to $250,000 per year, for 5 years. This amount doubles for the tax year 2023 to $500,000. Our average client saves between $50,000 to $60,000, but we estimate that about 2.5% of our clients will get over $250,000 for the tax year 2023 thanks to the Inflation Reduction Act.
You can save about 10 percent of your eligible R&D costs up to two hundred and fifty thousand dollars per year for up to five years. So, if you have about 2.5 million dollars in engineering R&D expenses for last year you can get close to a quarter of a million. And the amount is doubled thanks to the Inflation Reduction Act of 2022 for the tax year 2023 (which you will file for in 2024). Use our R&D tax credit calculator above to estimate how could save.
Many young companies with annual sales of less than $5 million can apply up to $250,000 of their research and development (R&D) credit to reduce their payroll tax liability. This amount doubles for tax year 2023 thanks fo the Inflation Reduction Act. This means that many unprofitable, young companies can cut their burn up to a quarter of a million dollars per year. This replaces the older rules that did not allow loss making businesses (i.e. most startups) from using these offsets until they generated an income tax liability (i.e. a profit!)
Your company should work with a qualified expert like Kruze to make sure that your business is eligible, and to conduct a solid study that only uses appropriate expenses that the IRS will agree with. And use our calculator to estimate your credit.
Yes. Your company does not have to be generating profits or positive net income to claim the payroll tax offset offered by the Research & Development credit. This is a very valuable, ROI-positive activity than an unprofitable startup can do to reduce their burn rate.
In addition to the federal credit, many state governments have incentives that dovetail with the federal R&D credit; some of these are helpful to VC-backed startups. Approximately 36 of the states have this credit: Alaska Arizona Arkansas California Connecticut Colorado Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Minnesota Nebraska New Hampshire New Jersey New Mexico New York North Dakota Ohio Pennsylvania Rhode Island South Carolina Texas Utah Vermont Virginia Wisconsin.
Specifically, other R&D tax credits for startups and their investors include:
Another incentive biotechnology companies in California should consider is the California Partial Sales Tax Exemption.
A common misspelling of R&D tax credit is “R7D tax credit” - where the “&” is replaced by the “7.” This happens because the number 7 key and the ampersand key are the same on most keyboards (of course, you need to hit shift 7 to get the ampersand). Don’t worry if you’ve made this mistake - we’ve all done it!!
And while you’re here, use our R&D tax credit calculator to estimate your possible savings under this government incentive!
The biggest technology companies in the US - Apple, Amazon, Facebook - have very sophisticated tax and finance teams. These teams conduct intense due diligence when they acquire startups - including looking at the R&D credits. Below is a typical question that a big tech company would ask a startup on their due diligence checklist:
Provide an analysis of all tax attributes (e.g., net operating losses, capital losses, built-in losses, R&D credits, etc.), including expiration dates of such attributes and any applicable limitations on the utilization of such carryovers.
One major advantage of working with Kruze is that we have accountants on staff who are used to answering these types of questions. We wouldn’t expect a startup founder to be able to provide such a detalied analysis - but we can!
Important Tax Dates for Startups