As a startup founder, you’re trying to keep as much money inside your business as possible. If you’re not capitalizing on the federal research tax credit — commonly called the R&D tax credit — you could be missing out in a major way here.
This credit lets you reduce your tax liability. The amount you can slash from what you owe depends on how much money you’re spending on research and experimentation, and where, exactly, that money goes. It can get complicated, but we’re here to help. Let’s dig into the details of this potentially huge savings opportunity.
Tapping into IRC § 41
Under the Internal Revenue Code, businesses have the opportunity to take a tax credit for increasing research activities.
This isn’t a one-to-one credit, meaning you don’t necessarily get to take $1 off your tax liability for every $1 you spend on research. Instead, you get to take a credit for a certain percentage of what you spend on qualified research expenses (QREs) over what the IRS calls your base amount.
This base amount gets calculated by looking at your average annual gross receipts for the previous four taxable years and this year, then multiplying that by a fixed-base percentage based on your business’s income and age. That percentage can range from 3 to 16%. It also can’t be less than 50% of your QREs for the given time period.
Setting your base amount aside, you can calculate your R&D tax credit by totaling up your QREs and multiplying them by the applicable tax credit percentage, which is often 20%.
Those QREs can be both in-house expenses and contract research expenses, including:
- Wages paid to an employee for qualified research activities
- The cost of supplies (including land) for qualified research
- Rental or lease costs for any computers you used in qualified research
- Money you pay to a qualified research consortium
While this credit can be a huge help, it does have limits. Note that you can’t deduct research expenditures as a business expense and claim the credit for them. In other words, there’s no double tax benefit here (unfortunately).
Like most of the IRC, this credit comes with a ton of nuance. Fortunately, our team specializes in this specific part of the tax code. We can help you identify QREs and maximize your credit for them.
To help you get a rough idea about how much your business could claim from this credit, we’ve got a handy R&D credit calculator ready for you. And if you want to get into all of the details of your research tax credit opportunities, read through Section 41 of the IRC.
This tax credit and small startups
We also specialize in supporting small, new startups. And that means we can help you tap into this credit earlier than you might expect.
What happens if your business isn’t grossing anything and consequently doesn’t have a federal tax liability yet? You can likely still get some advantages for your research expenditures.
Per the Protecting Americans from Tax Hikes (PATH) Act of 2015, if your gross receipts are less than $5 million and you’ve been in business for fewer than five years, you can most likely claim a credit of up to $250,000 to apply toward the social security tax on your payroll.
Using the R&D credit on your 2022 taxes
Because this tax credit comes with a lot of complicated aspects, most startups are better off hiring a professional rather than trying to file Form 6765 themselves. That said, if you feel like exploring that process, the IRS does have some pretty robust instructions.
If you decide you’d like to get an expert involved to maximize your 2022 R&D tax credit, we’re here. In fact, we have an established, streamlined five-step process you can use:
- Take a 30-minute interview with one of our R&D credit experts.
- Let us crunch the numbers.
- We submit the appropriate paperwork to the IRS so you can get the credit and we prepare Form 6765 so your accountant can include it in your annual tax return (we can also prepare your annual taxes, by the way).
- We give you a comprehensive R&D study report for your records.
- We only invoice you once your credit hits the bank.
We’re not ones to dine and dash, either. In the event your company gets audited, we’ll jump back in to ensure you have all the documentation and support you need.
State R&D tax credits
The IRS isn’t the only tax authority encouraging research and experimentation. The majority of states also offer some tax advantages based on the money you spend on research.
All told, it’s well worth carefully tracking what you think could count as a QRE — and familiarizing yourself with what that means on both a federal and state level.
Good news for 2023
While it won’t help with your 2022 taxes, you should know that the Inflation Reduction Act of 2022 may allow new startups to take a notably larger credit in future years.
As we mentioned, if your business brings in less than $5 million in gross receipts and is under five years old, you can apply up to $250,000 of your research credit toward your social security payroll tax liability.
Under the Inflation Reduction Act, you would be able to take $500,000 in tax credits to apply toward your Medicare hospital insurance tax, starting after December 31, 2022. See Section 13902 of the Act for more details.
As you start to think about your 2022 taxes, factor this potentially major tax credit into the mix. If you don’t, you could be leaving some serious money (think: $250,000) on the table. And when you’re building a startup, that can make all the difference.
Whether you want an expert to conduct an R&D credit study to calculate how much you can claim or you just want to chat with someone to see if your business has any expenses that could qualify, don’t hesitate to get in touch. Our R&D specialists are standing by. To explore claiming this credit for your startup, get in touch.