R&D Tax Credit can help your startup claim tax benefits that may provide immediate and significant cash savings.

Under the Internal Revenue Code Section 41, the R&D Tax Credit is a general business tax credit for companies that invest in scientific and technological development activities in the US. Since its introduction in 1981, many companies received significant dollar-for-dollar reduction of their federal (and state, if applicable) income tax liability. On December 18, 2015, the US Congress has expanded the R&D Tax Credit benefit by allowing certain small businesses regardless of company's financial status. This change provides startups with an opportunity to claim R&D Tax Benefits for innovative products and services being built and marketed by the company.

R&D defined in Sec. 41 is much broader than the traditional concept of R&D (e.g., scientists in lab coats working in clean-room laboratories). Many companies in various industries are unaware of their eligibility that their daily activities could qualify for this benefit.

Examples of potentially qualifying R&D activities

Software company developing application to manage large scale data and process them online to provide 'near-realtime' customer recommendations.
Hardware company developing a new IoT device to detect and eliminate harmful substances in nearby environments.
Manufacturing product line changes to significantly improve throughput and/or quality.
Biotech / Pharmaceutical company using artificial intelligence to diagnose patient's symptoms and customize the dosage levels.

To be considered as qualified R&D activity, the activity must meet each of the following 'Four Part Test'.

  
    The 'Four Part Test'
  
    Permitted Purpose
    The activity must relate to a new and/or improved business component, in respect to its function, performance, reliability, and/or quality.
  
    Technological in Nature
    The activity performed must fundamentally rely on the principle of physical, biological, computer science, or engineering.
  
    Elimination of Uncertainty
    The activity must be intended to discover information to eliminate uncertainty concerning the capability, design, function, and/or methods for developing and/or improving a business component.
  
    Process of Elimination
    The taxpayer must engage in an evaluative process (e.g., simulation, experiments, trial-and-error) that is capable of identifying and evaluating one or more alternatives to achieve a result.

The 'Four Part Test'
Permitted Purpose	The activity must relate to a new and/or improved business component, in respect to its function, performance, reliability, and/or quality.
Technological in Nature	The activity performed must fundamentally rely on the principle of physical, biological, computer science, or engineering.
Elimination of Uncertainty	The activity must be intended to discover information to eliminate uncertainty concerning the capability, design, function, and/or methods for developing and/or improving a business component.
Process of Elimination	The taxpayer must engage in an evaluative process (e.g., simulation, experiments, trial-and-error) that is capable of identifying and evaluating one or more alternatives to achieve a result.

For some products and processes built for internal-use (e.g., custom CRM system used within the company), additional qualification requirements exist.

Startups qualified for R&D Tax Credit can apply the benefits to offset either payroll tax, AMT, or corporate income tax, based on the company's circumstances. The R&D Tax Credit can generate immediate cash savings that can be reinvested to the R&D activity, or to other business operations.

R&D Tax Credit used to offset	High-level requirements (not comprehensive)	Most likely to be applicable for
FICA payroll tax	<$5M in gross receipts	Early-stage startups (even operating at a loss)
Alternative minimum tax (AMT)	<$50M in past 3-year average gross receipt	Mid-stage startups
Corporate income tax	All other scenarios	Late-stage startups and larger companies

Even in cases where a startup cannot immediately utilize the benefit, R&D Tax Credit can be filed as a 'carry-forward credit' in the tax return that can be used to offset liabilities in the future. In addition to generating benefit for future use, this also cues a positive signal about the startup's innovation capability that can further attract potential buyers and/or investors.

While R&D Tax Credit can be an extremely beneficial tax incentive for a startup, it requires navigating through a complex credit calculation process including assessment of QRE (Qualified Research Expense) and base calculation, as well as thorough and meticulous documentation supporting the claimed credit and the associated R&D activities, which is a burden of proof to the company. As such, many startups choose to work with highly qualified professionals with expertise in R&D Tax Credit to maximize the firm's benefit potential while being fully compliant and audit-ready.

Our dedicated team at Pinecone41 has deep expertise in R&D Tax Credit, and have helped many clients benefit from it. Contact us to discuss further how we can help your company.

* Please note that the information presented on this page are to be regarded as general information, and should not be interpreted as tax, financial, or legal advice.