The R&D Tax Credit program is a government-sponsored program that provides cash incentives for companies conducting R&D. This program totals around $10 Billion in tax incentives each year, and just last year changes were made to help extend this benefit to young, startup firms. The reality is that many more companies qualify for this benefit than those that realize, and with these new changes, companies in their early stages can take advantage to receive immediate, non-dilutive cash benefits that can help push their operations and growth forward.
How Startups Can Benefit
So, what were these changes? Perhaps the most significant was the change to allow companies that are less than five years old with less than $5 million in revenues claim the R&D credit against their payroll taxes vs. their income tax liability (which they may not have at all). This benefit can extend up to a total of $250,000 of eligible value. The tax credit can be up to 10% of eligible expenditures on R&D in any given year, so, imagine a 3-year-old company spending $750,000 on developing a new product or service. This company could receive up to $75,000 of direct tax offset to their payroll taxes the following year.
It’s important that companies begin to take advantage of it early. After five years, a company no longer qualifies for this payroll tax offset, but could still qualify for the traditional income tax version.
So, how does a startup begin the process? The first is to engage their tax advisor and/or a specialty tax firm to determine general eligibility. But, beyond that, the bulk of the time would be spent analyzing activities and measuring the amount of value that is eligible. This is where it is important for companies to have measurement programs in place as they can save a tremendous amount on fees with the advisors who would have to come in and conduct measurement studies. By setting up a time based or contemporaneous staffing based financial allocation to development efforts, the only process is then determining which efforts would be eligible (as a side note, these are often broader than those that would be eligible for CAPEX under GAAP).
Having a basic system of measurement set in place can help break down the barriers for small, growing companies to access the R&D tax credit benefits. More often than not, companies are recording great detail of the ‘what’ in their development process through user stories, requirements documents and/or project phasing detail, but just not clearly linking the dollars associated with these designations.