Research and Development Tax Credit

Filing for the the research and development credit can reduce an early-stage company's burn rate by up to $250,000 per year. It makes sense to work with a good CPA who is experienced with US R&D work, as the documentation requirements are more complicated that a typical return - and the audit risk is real.

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.

Not all scientific or engineering expenses are considered qualified research expenditures. So it makes sense to work with an experienced preparer so that you count all qualifying activities. Remember, the goal of the incentive is to drive scientific research in the United States, so your expenses should be in the US. The IRS has a 4 Part Test that defines qualified research expenditure:

• Specific: Also known as the "The Business Component Test." The project must be defined and geared toward creating a product, process, formula, code, etc. that will benefit the business.
• Eliminate uncertainty: must be contributing real scientific advancement, not just proving existing knowledge.
• Experimental: a qualified research activity must be conducted as a real scientific process, either through a scientific method or through a process to evaluate different methods/solutions. The good news is that most software research can be classified in a way that fits this particular requirement
• Technical: surveys and other non-scientific work do not count.

Yes. The IRS does not consider all scientific, coding, development etc. expenditures by corporate taxpayers to be qualified research expenses. These are a few of the research expenses that your company likely undertakes that can not be included in the calculation:

• 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.

What goes into the calculation of an research and development expense to capture the incentive in the US? The internal revenue code has specific definitions of constitutes research activity, but we've found that most companies will have four major types of qualifying expenses. If you think you have other research expenses that are not on this list, contact us and we can help you see if there is room in the internal revenue code for your R&D efforts.

Wages/Salaries. This is the largest component for most companies that we work with. There are some nuances to which salaries count - for example, it's important that the employee expenses used in this calculation are engaged in scientific work.

Contractors. US-based contractors only, and again, only ones who are engaged in qualified research activities.

Supplies. This includes the hardware and other materials that goe into what you are developing.

Computer leases. This is not as typical, but some eligible small businesses have particular computer expenses that can be included.

Here are the steps you'll need to take with your CPA to claim the credit:

1. File the Research and Development tax credit on Form 6765 (Credit for Increasing Research Activities) which is a part of your 2019 or 2020 annual US corporate return.
2. To claim the R&D payroll tax credit, you'll use form 941 (Employer’s Quarterly Federal Tax Return). Your payroll processor will have to process this for you. Every payroll company is slightly unique on how they execute this - and we've seen quite a few mistakes (which is one reason we recommend using Kruze for your bookkeeping, as we can help monitor your books to make sure you are capturing the credit.

For the 2019 tax year, which you will file in 2020, you'll want to begin working on calculating the amount as soon as your 2019 books are closed (or as soon as your 2020 books are closed for the tax year 2020 returns). When your CPA has calculated what the amount will be, they will add it to your 2019 annual corporate form 1120 and file the return (and if you are working on the 2020 tax year's return, they will add it to that filing). In the quarter following your 1120 filing, you can start applying those the credits to your payroll taxes.

A company can capture ~10% of eligible R&D costs, up to $250,000 per year, for 5 years. That may represent a meaningful improvement in cash flow!

Yes. In the United States, a "taxpayer" - i.e. your company - doesn't need to be net income positive, have taxable income (or generate cash flow/profits) to capture this research tax credit. That means that your Form 1120 can show no tax liability, but your company may still be eligible. The most important component to be an eligible small business is to engage in the "qualified activities."