There is a common misconception that pre-revenue startups cannot take advantage of the Research and Development (R&D) Tax Credit. This is simply not true. Here at Strike, we have helped numerous startups claim federal and state R&D tax credits they are entitled to, even before they generate any revenue. Most business owners are under the impression that the R&D tax credit can only be used to offset income tax liabilities. This was true prior to 2016. However, businesses can now use federal R&D tax credits to offset the employers’ portion of OASDI payroll tax (Social Security Tax).
Pre-revenue startups with no income tax liabilities are a focus at Strike. Before engaging with us, many of these companies had never heard of the R&D tax credit. What we have shown time and again is that this tax credit works for startups.
What is the R&D Tax Credit and How Can it Help Your Company?
The R&D tax credit has been in existence for decades, but many startups are under the impression that if they haven’t turned a profit, they don’t qualify. This is why the credit is especially overlooked among new, pre-revenue companies.
A legislative modification in 2016 opened the R&D tax credit to small- and medium-sized companies, including startups. Congress passed the PATH Act to allow pre-revenue start-ups to use R&D credits by offsetting employer payroll taxes. Essentially, this tax credit incentivizes companies to continue innovation by reducing their tax liabilities, and rewards the financial risks inherent to create the “next new thing”.
If your company the following requirements to be a Qualified Small Business (QSB), you can use the credit to offset your payroll taxes:
1) Has less than 5 million gross receipts in the credit year, and
2) Has no gross receipts (including interest income) in any year prior to the 5-year period ending with the credit year, and
3) Has Qualified Research Activities and Expenses (QRAs and QREs)
How much are we talking about here?
Startups can convert up to 10% of the money invested in R&D into a federal tax credit against future payroll tax, current income tax, or past income taxes already paid. Depending on the state where the activities are performed, you could add an additional 15% towards state taxes. That’s a potential 25% return on investment.
Since pre-revenue companies have typically never paid income tax liability, Strike can calculate credits all the way back to inception and those credits can be carried forward up to 20 years. This means after turning a profit, companies can then continue to save on their federal and state taxes. A qualified startup with less than $5 million in annual gross receipts can apply up to $250,000 toward payroll taxes each year.
Does Your Business Qualify?
One of the most important points to remember is that startups aren’t required to demonstrate success to be qualified. Risk-taking and failure is rewarded. In fact, the tax credit acts as an incentive to cushion the financial risk on the path towards innovation. Although this credit is designed to benefit startups, it is the company’s job to file effectively and precisely. Early planning for the credit is key, as payroll tax credits can’t be claimed on amended returns. If you think your company qualifies, and you don’t want to leave any money on the table that could be used to grow your vision, contact STRIKE today and speak to one of our experienced advisors.