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As a startup, every dollar counts. You’re trying to stretch your limited funding as far as possible while building your business. One way to free up some extra cash is through R&D tax credits. If you’re a qualified small business that devotes resources to making products, processes, or software better, faster, cheaper, or more sustainable, you may benefit from R&D tax credits even if you have no income tax liability.
Startup taxpayers, in certain circumstances, may offset up to $500,000 of their FICA federal payroll tax liability — for up to 5 years — using R&D credits. The 2022 Inflation Reduction Act doubled this, bringing the previous limit of $250,000 to the current $500,000.
Companies across a variety of industries can benefit from the credit. Businesses founded in the past five years and with less than $5 million in revenue may be eligible. Qualifying research activities don’t need to be flashy or revolutionary, or even succeed.
Does your startup qualify?
Startups should think about the tax credits before tax time and in the earliest days of the new business. The IRS has created a four-part test to find out if your company qualifies for R&D tax credits:
Purpose – The purpose of your research and development activity must create a new or improved function, performance, reliability, or quality for a business component.
Eliminate uncertainty – Businesses that qualify for the R&D tax credit must encounter a problem with a high degree of technical uncertainty and try to solve it using their own procedures.
Technology – The research must be technical in nature—and to be considered technical in nature, an activity must heavily rely on a hard science.
Experimentation – According to the IRS, the process of experimentation must include simulation, evaluation of alternatives, systematic trial and error, testing, modeling, and refining.
Documentation is key for the R&D Credit:
Your business’s bookkeeping is key to identifying research activities that qualify your startup for R&D tax credits in case the IRS asks for justification of R&D expenses. Costs that should be noted include:
wages for employees who perform, support or supervise R&D activities,
third-party contractors working in the U.S. that perform R&D activities and
supplies and materials used in the development process, including payments to cloud service providers.
The takeaway:
As an entrepreneur, you pour so much blood, sweat, and tears into building your startup. The R&D tax credit was created to reward that entrepreneurial spirit of innovation. So remember, while you’re heads-down working to build the future through technology, you can get up to $500,000 back per year from the government to help fuel your startup’s growth.
Our team at Saba Tax Advisory can help you with claiming R&D tax credits, which will allow you to retain more of your hard-earned capital to continue pushing the boundaries, disrupt industries, and build a better tomorrow.
The information provided in this blog is intended for general information only, and is not meant to constitute tax advice.
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