Research and Development (R&D) credits are not just incentives; they’re powerful tools that can significantly impact a tech start-up’s financial landscape. Designed to foster innovation and reward businesses that invest in groundbreaking projects, these credits can offer substantial tax savings. But to maximize their benefits, it’s crucial to understand their nuances.
Federal R&D Tax Credits
At the federal level, the R&D tax credit, often referred to as the “Research Tax Credit,” allows businesses to deduct qualified research expenses (QREs) from their taxable income. These QREs can include:
Salaries of employees involved in R&D activities.
Costs of supplies used in research.
Contract research expenses.
Payments to certain research consortia and universities.
Key Consideration: The federal R&D tax credit is available to businesses of all sizes. However, start-ups, especially those in the tech sector, might be eligible for up to $250,000 per year against their payroll tax liability if they have less than $5 million in gross receipts.
State-Level R&D Tax Credits
Many states offer their own R&D tax credits, which can be claimed in addition to the federal credit. The specifics vary by state, with some offering more generous credits than others. For instance:
California: Offers a 15% credit for qualified in-house research expenses and a 24% credit for basic research payments to outside organizations.
Texas: Provides a choice between a sales tax exemption and a franchise tax credit for businesses engaged in qualified research.
Key Consideration: It’s essential to be aware of the specific criteria and requirements of each state’s R&D credit program. Some states might have stricter definitions of what constitutes R&D, while others might offer credits only to specific industries.
Things to Consider When Claiming R&D Credits
Documentation: Proper documentation is crucial. This includes maintaining records of project objectives, challenges faced, solutions attempted, and project outcomes.
Eligibility: Not all research activities qualify. The research must be technological in nature, must be for a permitted purpose (like new product development), must involve the elimination of uncertainty, and must involve a process of experimentation.
Potential Scrutiny: R&D credits are often a focus area for IRS audits. Ensuring compliance and maintaining robust documentation can help in navigating any potential inquiries.
Carry forwards: If you can’t use the entire R&D credit in the current year, federal and most state credits can be carried forward for future use. This can be especially beneficial for start-ups that might not have significant tax liabilities in their early years.
Reach out to one of our R&D experts at Taxfully to discover more
