Did you know that your business could qualify for a tax credit of up to $250,000? The federal startup R&D tax credit allows new businesses to reduce their payroll tax by a set percentage of their research and development (R&D) expenses, with a maximum reduction of $250,000. With such a large financial incentive, it pays to start thinking about the R&D credit well before tax time and from the earliest days of starting your business. In this article, you’ll learn the basics of applying for the federal startup R&D tax credit, plus how to calculate the amount for which you’re eligible.
Businesses from a broad range of industries can apply for the federal R&D tax credit, including engineering, manufacturing and software development companies. To apply, a business must fulfill two conditions:
It must have less than $5 million in gross receipts in the current tax year.
It must not have gross receipts from more than five years before the current tax year.
Which business expenses qualify for the R&D Tax Credit?
If your business is eligible for the credit, you can use the money spent on certain research and development expenses to offset the amount of payroll tax you pay. R&D tax credit qualified research expenses (QREs) include:
The cost of hardware and supplies used to build your product. This does not include capital items or general administrative supplies.
The cost of leasing computers used for R&D activities.
Fees you pay contractors to contribute to R&D projects in the United States.
Wages you pay employees to work on qualified research activity. Keep track of the time that employees from all departments (including founders and CEOs) spend on R&D activities, so you can include the relevant portion of their salary as an R&D expense.
How To Calculate Your Startup R&D Tax Credit
Once you have identified your total qualified expenses, there are two methods for R&D tax credit calculation:
Traditional method: The traditional method of calculation is 20% of the current year QREs that exceed a base amount. To calculate the base amount, apply the percentage of gross receipts historically spent on qualifying expenses to the average annual gross receipts over the past four years.
Alternative Simplified Credit (ASC) method: The ASC method of calculation is 14% of the current year’s qualified expenses that exceed 50% of the average qualified expenses for the past three years.
For both calculation methods, the resulting figure is the amount of the credit the taxpayer can use to offset the payroll tax. Tax accountants calculate the R&D credit with both formulas and use the method that results in a larger credit for your business, so you may end up switching methods from year to year.
How To Apply For The Startup R&D Tax Credit
To apply for the startup R&D tax credit:
Keep granular records of every business expense throughout the year—As well as allowing you to monitor performance against the startup budget, this recordkeeping also helps identify which expenses qualify for the credit and which do not. Without detailed records, your team will have to waste time clarifying the details of each expense before you can put together the necessary supporting documents for your application.
Discuss your situation with an accountant—If you’re working with an accountant to file your taxes, arrange a meeting to explain your product, research processes, and team structure before they begin the application on your behalf.
Complete the application form—Complete Form 6765 (Credit for Increasing Research Activities), which is part of the annual corporate tax return, and submit the required documents as proof.
Once your R&D credit is approved, you can apply the value of the credit to offset your payroll tax liability.
Need the help of a startup tax expert?
The calculation and application process outlined above might seem complex—for most businesses, it often is complex. Startups that try to apply for the R&D tax credit without the guidance of an accountant risk missing out on thousands of dollars of credit and not being prepared for an IRS audit. If you’re looking for an expert to help you navigate the confusing world of corporate tax, Zeni might be the solution your business needs.
Built specifically to meet the needs of startups, Zeni is an AI-powered finance concierge that manages all your bookkeeping, accounting, invoicing, bill pay, reporting, and more. Our team maintains detailed, GAAP-compliant records for your business year-round, and, for a fixed fee, we can take care of all your federal, state, and local tax returns, so you can be confident that your business isn’t leaving money on the table.
Zeni is a new age, full-service finance firm, built from the ground up using AI & ML, for startups and small businesses. Zeni’s AI and Finance Experts collaborate together to deliver 100% accurate accounting