Launching a startup is exciting, but with a growing startup comes tax responsibility. Why wouldn’t you add in taxes? You can file online, and most business credits are self-explanatory.
However, the most internet-savvy founder can easily tax credits specifically for startups. When you miss a tax credit, you give up an essential piece of startup success.
Money.
Targeted credits and deductions are to put cash back in your pocket. The most experienced CPAs miss startup-specific credits because they need direct experience. You need a guide to spot the hidden credits when traveling down the tax road.
Why You Shouldn’t Miss Out On Startup Tax Credits
Startup taxes are a headache, but they can be highly beneficial when filed correctly. Tax credits are a piece of the money-saving puzzle in addition to tax deductions.
Whether you’re bootstrapping or have taken VC, you know what it costs to run a business. The IRS constructed credits to aid in cutting down on that cost during the tax season. Startups can qualify for general business-targeted tax credits and dedicated startup credits.
Glossing over tax credits designed to cushion the impact of startup costs is like throwing money out the car window. Hiring a CPA is among the best options for first-time startup tax filers. But, your CPA needs experience in startup taxes to be beneficial.
What Are Tax Credits For Businesses?
Business credits are distinctive opportunities for businesses to reduce their taxes owed. If your startup fulfills specific requirements through its actions, you automatically qualify.
Tax credits lower the total amount you owe to the IRS on income tax. A deduction lowers your taxable income.
A tax incentive reduces the amount owed for businesses that completed an action benefiting the economy. The Work Opportunity Tax Credit is well-known. Utilizing incentives, credits, and deductions drastically lowers what you owe.
Tax deduction example:
If you make $50,000 a year and earn a $1,000 tax deduction, the IRS will tax you as though you made $49,000 that year.
If you calculate using the 2022 tax brackets, the deduction would mean you have to pay $6416.66. The original owed would be $6616.66, for a savings of $200.
Tax credit example:
If you have a $50,000 salary and earn a $1,000 tax credit, your total taxes would be $5616.16 instead of $6616 — a $1000 savings.
Tax deduction and credit combination example:
If the same person with a $50,000 salary takes the standard deduction of $12,950, their taxable income would be $37,050.
With that taxable income, they would owe $4288.10 in taxes. If this person also had a $1000 tax credit, they'd remove that $1000 from the $4288.10 they owe, meaning they now owe $3288.10.
Tax Credits To Pay Attention To
Often, tax credits only apply to a narrow subset of startups depending on their size, location, and type of business. However, some tax credits apply to a much more comprehensive range of startups. Taxes credits aren’t a place you want to speed through. If you’re managing your taxes, carefully comb through all credits.
We’ve done some legwork for you to make your life easier.
1. State R&D Tax Credits
Any startup doing research and development in the states listed below is eligible. Startups that meet the criteria receive a specified percentage dependent on state laws.
You can use State R&D tax credits in tandem with federal R&D tax credits, but each will reduce the tax based on qualified expenses on their associated return.
2. Tax Credit for Retirement Plans
Employers often set up company retirement plans, such as 401ks or Simple IRAs, for their employees. If you have fewer than 100 eligible employees, the tax credit covers 50% of the plan's cost for the first three years.
3. Tax Credit for Work Opportunities
The federal government created the Work Opportunity Tax Credit to aid in employment. Businesses will receive tax credits for hiring people from specific groups.
- Recipients of state assistance
- Ex-felons
- Individuals who have completed a rehabilitation program
- Veterans.
During the first year of employment, your business will be eligible for either:
- $2,400 in credits
- 40% of the first $6,000 of the employee's wages
4. Tax Credit For Health Care
The IRS' Small Business Health Care Tax Credit offers credit to employers who offer health plans through the Small Business Health Options Program Marketplace. Qualifying startups that pay at least 50% of the health plan premiums are eligible. The smaller the business, the larger the tax credit received.
5. Employment Zone (EZ) Employment Credit
Startups operating in specific regions qualify for the EZ credit. The IRS targets these areas to push economic growth and heighten commerce traffic.
Empowerment Zones:
- Pulaski County, AR
- Tucson, AZ
- Fresno, CA
- Los Angeles, CA (city and county)
- Santa Ana, CA
- New Haven, CT
- Jacksonville, FL
- Miami/Dade County, FL
- Chicago, IL
- Gary/Hammond/East Chicago, IN
- Boston, MA
- Baltimore, MD
- Detroit, MI
- Minneapolis, MN
- St. Louis, MO/East St. Louis, IL
- Cumberland County, NJ
- New York, NY
- Syracuse, NY
- Yonkers, NY
- Cincinnati, OH
- Cleveland, OH
- Columbus, OH
- Oklahoma City, OK
- Philadelphia, PA/Camden, NJ
- Columbia/Sumter, SC
- Knoxville, TN
- El Paso, TX
- San Antonio, TX
- Norfolk/Portsmouth, VA
- Huntington, WV/Ironton, OH
6. Maryland Biotechnology Investment Incentive Tax Credit (BIITC)
Startups operating in Maryland with a focus on biotechnology receive a tax credit of up to $250k. Maryland continues to encourage growth within this specific industry. If your startup r is looking for an investment opportunity, this is a huge one.
7. CA Sales Tax Exemption
Startups in specified industries operating in California can apply for this exemption. Qualification depends on your startup’s NAICS classification.
- 3111 - 3399
- 541711
- 541712
- 221118 - 221122
The codes above qualify for this exemption. There are specific tangible purchasing qualifications alongside the coding requirements. Examples of qualified purchases:
- Machinery
- Equipment used for repairs or maintenance
- Operational equipment (computers, printers, etc.)
- Tangible personal property used in pollution control
- Special-purpose buildings used in production
The Most Important Business Startup Tax Credit: R&D
One major tax credit that startups should know about is the federal R&D tax credit. You qualify if your startup made less than $5 million in annual receipts and technology design.
Qualifying startups can receive a payroll tax credit of up to $250,000. You can apply money spent on supplies, consultants, employees, and computer rentals. Ensure you keep accurate records of your expenses to track how much money is applicable.
Startups, especially SaaS-based ones, spend a lot of money on research and development. Once launched, it will take a while to produce enough revenue to offset that cost. Taking advantage of federal and state R&D puts money back into the company.
The majority of startups qualify for this specific tax credit. If you’re working with a CPA, double-check that they’re utilizing this credit.
Changes To The R&D Tax Credit Section 174
In 2017, the Tax Cuts And Jobs Act updated businesses’ ability to expense their section 174 costs. Section 174 expenses now must be capitalized and amortized by domestic and foreign research.
- Domestic Research - capitalize all costs over five years utilizing a half-year convention.\
- Foreign Research - capitalize all costs over 15 years utilizing a half-year convention.
The changes implemented may change your 2022 taxes. If you’re self-filing, research these changes thoroughly before applying for the federal tax credit.
How To Take Advantage of Tax Credits
Working with a highly experienced CPA in startups and different verticals is the key to gaining every credit available. Taxes require attention to detail and knowledge of state and federal tax laws. Due to the sheer volume of tax credits available to startups, the benefits of a professional outweigh the cost.
If you believe your startup qualifies for one or more tax credits, you must fill out Form 3800. The instructions for how to fill out the form are relatively extensive and subject to change. The IRS requires you to list how much you're claiming per credit.
These forms each have their own requirements. However, on every form, you must calculate the amount of credits you can claim
Things To Avoid When Claiming Startup Tax Credits
When dealing with complicated business taxes, you can make plenty of mistakes. Potential missteps encompass all aspects of business taxes, including applying for tax credits. Here are some common pitfalls you'll want to avoid:
Poor Record-Keeping
Many tax credits depend on knowing how much you've spent on certain expenditures. The more you spend, the higher your tax credit. Others require you to know information about your employees' prior economic status.
You need to keep track of this information correctly to understand how much of a tax credit you can claim. The last thing you want is to fill out a tax credit form and realize you need to know what information to enter.
Failing To Apply For Tax Credits In The Right Order
Not only do you need to calculate each of your business's tax credits on separate forms, but you also need to apply for them in the correct order. The order you apply the credits depends on when you used them and what type of credit they are. The IRS provides a detailed list of the order in which you must apply for tax credits.
Forgetting To Apply For Carryforward And Carryback Tax Credits
Businesses can often qualify for more tax credits than they can apply to their taxes in a single year. To mitigate this, the IRS lets companies apply unused tax credits to future years. The IRS also allows startups to use certain unused tax credits for prior taxable years. Each credit has different rules for how far forward or backward you can apply it.
Why Shouldn’t I Apply On My Own?
The short answer: taxes are complex and rely heavily on correct filing. The advantages of using a tax advisor or CPA far outweigh the benefits of doing your taxes. CPAs have a cost, but the money saved on hiring costs pales compared to the money saved using tax credits and deductions.
A professional should comb through the sheer amount of deductions and credits applicable to startups. Researching on your own uncovers a few, but experts know where to find those hidden gems.
Incorrect filing or missing the filing deadlines comes with penalties and fees.
We know from our tax filing blunders with our first startup. During our first tax cycle with a CPA, many credits were missed due to the CPA’s lack of experience with startups. We lost money and paid more.
Maximize Your Tax Benefits
Tax credits were designed to help your business. The IRS designed startup-specific tax credits to offset the high costs of growing a business. All tax credits apply to fiscal or calendar tax year filers.
If you’re filing yourself, and you’re not a CPA, there’s a high chance you’ll miss essential credits. That’s just money down the drain. Instead of fighting through your tax cycle, make the most of the tax year.
Tax professionals and CPAs focused solely on startups are out there. Their entire job description is helping founders make the most of every tax credit. In addition to the tax credits we’ve listed, there are industry-specific credits.
We can help you find and claim the credit you deserve. Schedule a free consultation with us.
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