Curt Mastio
By Curt Mastio on June 18, 2024

How Startups Should Use the R&D Tax Credit

The R&D tax credit is a great way to offset the cost of research and development. The tax credit incentivizes research by helping startups, and mature companies reduce their tax burdens, leaving more resources for business growth. 

Many new businesses don’t make it past the first ten years. A competitive and challenging business landscape can make it difficult to hit profitability. Startups that survive must be innovative and agile and use every lever possible to boost innovation and help the firm grow. 

Can the R&D tax credit benefit your startup?

What is the R&D Tax Credit?

The R&D tax credit is a federal program that provides incentives to companies that conduct research and development activities within the United States. It’s a federal tax credit that allows companies to deduct up to 6% to 14% of qualified research expenses from their annual income tax liability. 

Qualifying companies engaging in research, experimental development, and experimental use of new or improved processes and production methods, including computer software, can claim the R&D tax credit. The credit is also available for research activities that promote economic development and innovation.

Qualifying businesses can claim the credit for up to five years to help offset the cost of new product development, inventions, and processes. The amount of money a company receives depends on its annual gross receipts and its level of investment in research and development activities during the previous year. 

How Can the R&D Tax Credit Impact Startups? 

Imagine you’re a small business owner with an excellent idea for a product or service that could revolutionize the world. You want to take advantage of all the tax credits and incentives available to entrepreneurs. Tax credits like the federal R&D tax credit can help your firm grow and become competitive.

The R&D tax credit program rewards innovative companies for investing in research and development efforts. It can be a great way to reduce your burn rate by offsetting some of your company’s R&D spending, reducing your tax liability, and encouraging innovation.

For five years, you can claim up to $250,000 ($500,000 starting in 2023) in tax credits annually for eligible R&D expenses. Furthermore, the credits can offset income or sales taxes and help maximize your company’s value. 

R&D Tax Credit

Does My Startup Qualify for the R&D Tax Credit? 

The R&D tax credit provides a refundable federal tax credit to companies of all sizes and industries with qualifying research and development activities. 

To claim the credit, your research and development costs must fall into one of the following categories:

  • New-to-the-world products, processes, or services;
  • New technologies;
  • Precisely engineered products or processes; or
  • Technology-enabled product improvement where a significant increase in quality or performance is achieved.

What Expenses Apply? 

It’s essential to start thinking about tax credits long before tax time, as qualifying expenses must meet specific criteria and you will need to document them well. Typically, qualifying costs include the following:

  • Expenses for equipment and supplies used in the specified R&D activities;
  • Employee salaries, wages, benefits, and travel costs
  • Contract research costs (but at a reduced percentage)
  • Costs related to the design, development, prototyping, testing, and evaluation of the qualifying research activities

How Do I Claim the R&D Tax Credit?

Claiming the R&D credit can be complex, and having a qualified CPA can help. The credit applies for past qualifying research expenditures against payroll tax liability or income taxes. 

To claim the credit, the qualifying activities must meet the following criteria:

  • You must be improving an existing component or developing a new component that the company will sell
  • The research must intend to discover new information necessary to make the improvement or developments possible
  • Experimentation must be involved
  • Research needs to rely on hard sciences (i.e., engineering or computing, chemistry, physics, or biology)

Having good records about the R&D project through proper expense tracking is essential. To smoothen the process, include detailed descriptions and ensure you have supporting documentation like project proposals, publication records, and lab notebooks. 

You can also hire an R&D credit expert to determine your eligibility and help you claim the credit. The tax expert can help reduce your tax liability by ensuring your startup complies with all regulations and reducing the likelihood of an audit.

R&D Tax Credit

Need Help Claiming the Credit? 

The R&D tax credit is a powerful incentive for businesses to invest in research and development. Unfortunately, this benefit is not without its complications. It helps to plan throughout the year to claim this credit. Considering the complexity of the process, it’s best to consult a qualified tax and accounting professional who can help you through the process.

Founder’s CPAs are experts in navigating complex tax credit claim processes. Contact us, and our experts can help you get started with planning for the R&D tax credit today.

Published by Curt Mastio June 18, 2024
Curt Mastio