If taxes are on your mind right now, you're not alone. Everyone is thinking about taxes this time of year. And everyone is looking for ways to reduce their tax liabilities. Afterall, who wants to pay more in taxes?
If you're a startup, burn rate, runway, growth rate, buying that new ping pong table, and hiring those high-priced engineers who want to leave the enterprise world are all factors within managing upward mobility in an era where getting investment money is critical for success.
We've got a secret for you: there are business credits and tax incentives that could change how your startup or small business operates for decades to come. All you have to do is know how to access this information and unlock the potential for your company by doing the work you're already doing.
The Research and Development Tax Credit
One of the most innovative ways to reduce tax liability is the Research and Development (R&D) tax credit.
Regardless of a company’s size, success happens when minds are focused on change. Some of the world’s best inventions came at the 11th hour when it seemed like a breakthrough was lightyears away.
These innovations can change the world, but in most cases, those “aha” moments didn’t happen immediately. No, it took years of endless tweaking, testing, and failure. Otherwise known as research and development!
Unknown to most startups, is that they’re eligible to receive these credits for their annual investments in the innovative work they’re already doing! And it doesn’t matter if their product is commercially available or if they are making money from it yet.
In a nutshell, the R&D credit is the government’s way of rewarding companies for investing in innovation and building cool stuff!
Does my business qualify for the R&D Tax Credit?
We’ll keep it simple here. At the most basic level, you can ask yourself the following questions to determine if you qualify:
Do I make something?
If you’re developing or improving upon technology or products, odds are you probably are entitled to some money back from the IRS!
Does my product change over time?
Businesses rarely make their products the exact same way year after year. So, if your company invests resources to make its own products, software, or processes cleaner, greener, quicker, or cheaper, you most likely qualify for the credit!
Startups that can claim the credit come from a variety of industries. Some of these industries include but are not limited to:
- Artificial intelligence
- Consumer packaged goods
- Software/Software as a Service (SaaS)
- Virtual reality
How to Apply for the R&D Tax Credit
Businesses claim the R&D Credit by filing IRS Form 6765. As part of this process, they need to identify their qualifying expenses and provide adequate documentation that shows how they meet the requirements.
In a sense, you're going to need a paper trail.
Some things to keep in mind:
- The documentation should be from the time the R&D was done
- It should prove that the work occurred in the fiscal year you are claiming
- It should highlight the technical challenges to substantiate the R&D that was done and who was involved.
Some examples of what you can provide are:
- Technical documents
- Whiteboard or product roadmaps
- Timesheets for technical staff
- Development/engineering notes
Keep in mind, a well-documented report should always be included with your R&D credit calculations for tax filing.
What expenses can my business claim?
There are four buckets of expenses you can pull from when calculating your R&D credit savings. These include:
- W-2 Wages for any employee involved in R&D activities based in the U.S. – including supervision, support, or doing the actual work
- Contractors who are U.S. based
- Materials used for prototyping and development throughout the process of working on your product or service
- For SaaS companies - cloud costs for your pre-production and staging environment (think Google cloud, AWS, Heroku, etc.)
What can I expect back?
As a general rule of thumb, you can earn up to 10% back of what you've spent on product development.
Say for example, your company paid $200,000 in W-2 salaries to software engineers in 2021. Through the R&D study process, you can expect up to $20,000 in relief against your federal tax liabilities. If you spent $500,000 in W-2 salaries, you can expect up to $50,000 back, and so on.
Plus, any unused credits carry up to 20 years, which companies in the know use to factor in how they plan for the long term!
Keep Your Company Thriving
Don't miss the opportunity to transform your business, whether big or small. This credit can be a lifesaver if you're creating new things or improving upon old processes. Full stop.
If your company meets the standards outlined above, a discussion with an R&D expert may be worthwhile. And who knows, maybe your tax savings will help fuel your company’s next big project, key hire, or simply give you some extra breathing room this year (exhale)!
And if you’re interested in taking a deeper dive into the R&D credit, we cover it in greater detail in our Ebook: R&D Tax Credits, The Ultimate Beginners Guide. By the end of it, you’ll be an expert in the R&D credit yourself!