1. The R&D tax credit will be there for you—it’s now permanent
The U.S. government formally recognized the economic value of research and development (R&D) in 1981, when the original R&D tax credit was offered to taxpayers. Lawmakers hedged their bets at the time, however, designing the credit to sunset in 1985.
And their subsequent behavior reflected some ambivalence: the credit has been allowed to expire eight times and was extended 15 times. In 2015, the U.S. finally ended the will-they-won’t-they guessing game for taxpayers by going all-in on R&D: The Protecting Americans from Tax Hikes (PATH) Act made the credit permanent. You can now turn off your Google alert and fully focus your attention on how to innovate with R&D.
2. More than ever, your R&D spend is likely to qualify
R&D activity no longer has to clear the very high bar of being “new to the world” to qualify for a credit. Instead, since the elimination of the Discover Rule in 2003, your activity only needs to be “new to the taxpayer.”
Improving an existing product (even if someone else made it first!) is potentially as valuable as coming up with something entirely novel. So, if even you’ve been busy re-inventing the wheel, your expenses will likely qualify.
3. Two credit methods make it easy to apply (but check the math!)
The regular research credit (RRC) amounts to 20% of qualified research expenses (QREs) over a base amount calculated as a percentage of historical gross receipts. Some companies think this means you need a long history of qualified expenses and gross receipts to use this method, but in fact, the calculation is simple and taxpayer-friendly for the first five years.
If you’ve only just gone into business (or only just started incurring QREs) you’ll be well positioned to have all the information you need to take advantage of the RRC.
You’re also able to use the alternative simplified credit (ASC), which offers a credit for 6% of QREs to businesses with no qualified investments in one or more of the preceding three years. (After three years, the credit is equal to 14% of QREs above 50% of your three-year average.)
The ASC is so named because for long-tenured companies it can be simpler than the RRC, but for start-ups, RRC may yet have it beat in simplicity and ease of use. The best part? You can choose the best method for your company each year. The prudent taxpayer will calculate their credit under both methods each year and select the one that provides the best benefit.
4. Even if you are pre-revenue, the benefit is still for you
If you are like most startups, you have not yet recorded any taxable income. That, however, should not stop you from claiming an R&D benefit. Thanks to the PATH Act, if your company has less than $5 million of gross receipts (and have had gross receipts for less than five years), you can use up to $250,000 of R&D credits to offset your payroll tax liability.
You can claim this benefit every year for a maximum of five years (depending on when you start generating gross receipts) and carry forward any credits you leave unutilized. You can choose how much of your credit is allocated to offsetting payroll taxes and income taxes, allowing you to optimize for your particular facts and circumstances.
5. More help is on its way
Despite all the good news for startups, the generosity of the U.S. R&D regime finishes only 24th in a ranking of 34 OECD countries—but perhaps not for long. There are several legislative efforts underway, many of them bipartisan, promising bigger and better incentives to foster innovation.
- The FORWARD Act of May 2020 proposed making the payroll offset available to companies with up to $20 million of gross receipts, up from the original $5 million, and giving them eight years to claim, up from five.
- The American Growth Act of October 2020 called for a doubling of the R&D credit to 40%.
- The American Innovation and R&D Competitiveness Act of February 2021 was introduced in the House with the express purpose of repealing the provision of the 2017 Tax Cuts and Jobs Act (TCJA) requiring amortization of R&D spending.
- The IGNITE American Innovation ACT of May 2021 would allow smaller companies to receive an advanced refund of up to $100 million of net operating losses (NOLs). The White House has called for significant new investments in U.S. R&D—including a $300 billion investment in breakthrough technologies, with a goal of enabling an estimated five million new jobs in manufacturing and innovation.
As the founder of a recent startup, you have a lot on your mind, a full-to-bursting Outlook calendar, and probably not a few sleepless nights ahead of you. But lawmakers recognize the good work you’re doing, and they want you to do more of it. So, make some time to claim your R&D benefits. Why not? It’s easier and more generous than ever before.
