Every year, the United States Government gives billions of dollars to innovative companies and businesses for creating or improving current technologies, processes, materials, and products. These incentives are provided by the U.S. Research & Experimentation Tax Credit program or R&D tax credit for short.
You may wonder why the government is willing to provide these incentives. However, when you think about it, you will realize there are all types of variables to building a successful startup. It probably seems impossible to get ahead without reducing or increasing your costs. As a founder, you must leverage and test different strategies to increase your bottom line and maintain your business.
The chances are that taxes are the last thing you’ll think of as a financial savings strategy, and taking time to familiarize yourself with government incentive programs is probably one of the last things to cross your mind.
Don’t worry; you aren’t alone if this is the case. Around 80% of startups are unaware they are eligible for government-sponsored tax credits or don’t have easy access to them. However, knowing what the credits are and how to utilize them can help your business save thousands of dollars per year. Even better, it’s not just for large businesses.
Related: Business Startup Costs and Tax Deductions
Seed Funding: What Is It?
A startup company’s first round of funding is called seed funding. In most cases, angel investors, friends, family, or the company’s founders will provide the initial funding.
As funding from family and friends can go so far, startup owners may look to receive funding from their savings accounts or a bank loan. In the startup stage, seed funding is used to launch the business. Despite seed funding being risky, it is essential for a company’s growth, and seed funding is necessary for the success of a business idea.
How Is Seed Funding Beneficial to Startup Companies?
The financial benefit of seed funding is obvious, but the benefits of having investors behind you go beyond cash. Unfortunately, an unproven startup poses significant risks for investors.
Seed funding has the advantage of your investors understanding this risk and being willing to cover it. Your investors will also be able to help you grow and develop your startup in ways you might not have considered otherwise.
Plus, you will have access to and benefit from your investors’ strong business networks. As an added benefit, seed funding does not come with any debt or restrictive agreements so you won’t be stuck into a long-term loan.
When Should You Look for Investors for Seed Funding?
It is difficult to determine when to seek investors for seed funding as a startup company. You may believe it’s a great idea to seek seed funding as soon as you think of your business idea. However, you’ll have to build your business first before looking for investors for seed funding.
In order to build a company that deserves venture capital backing, you need a strong product, market, and team. The idea here is to scale up to the point where an investor can generate a solid return.
First, start by identifying your target customers and market opportunity. If you can solve a pinpoint with your products for your target customers, you have a strong product and market opportunity.
Next, build a team for your company that believes in your product as much as you do. Also, be sure to have a strong business plan detailing your finances, marketing goals, and revenue. Once you have this together, it will be the perfect time to seek investors for seed funding.
Understanding the Research and Development Tax Credit Program
The R&D tax credit program stimulates economic growth by encouraging companies to invest in new technologies, innovation, and research.
This program was originally introduced in 1981 and was regularly renewed in the following decades. The PATH Act was signed by President Barack Obama in 2015, which extended the R&D tax credit permanently. This Act also expanded several of the provisions.
Starting in 2016, the R&D tax credit was used to help offset alternative minimum tax, and startup businesses could use this credit against payroll taxes. Additional changes were made by the Tax Cuts and Jobs Act, which became effective in 2022.
Tax credits allow you (the taxpayer), which may be a business, to offset the value of the credit against your tax liability. Based on information from the IRS, the R&D tax credit is used for expenses paid or incurred for any qualified research.
Do you want to learn more about business tax credits? If so, be sure to contact us today.
Can You Claim the R&D Tax Credit During the Seed Business Stage?
R&D tax credits allow startups to deduct a portion of their qualified research expenses, which would otherwise be taxed. By claiming the tax credits, you’re able to lower your taxes.
If you know your business research meets the four-part test for the R&D tax credits, it’s an excellent idea to see if you can get this tax break. Usually, if any research is done to improve a product, service, or technology, a company can receive an R&D tax credit.
The best way to know if your startup company can receive the credit during the seed stage is to contact a tax professional. If you need to speak with a professional, contact one of our R&D tax experts.
What Startup or Small Businesses Qualify?
Certain criteria must be met to qualify for the R&D tax credit. These criteria include:
- Businesses that have gross receipts of $5 million or under for the tax year
- Total gross receipts for five years or fewer
- Is not tax-exempt based on section 501
If you meet these criteria, then you may be able to take advantage of the R&D tax credit.
It’s also worth noting that the R&D credit isn’t just for heavy research businesses. It’s best to look at the innovative activities on a higher level since this program is rather robust. Businesses in several industries can claim this credit, including those in:
- Artificial Intelligence
- Consumer packaged goods
- Virtual Reality
- SaaS and Software
- Oil and Gas
Also, when trying to determine if your business qualifies, ask yourself:
Does your business make something?
If your business is improving on or developing technology or products, you will likely be due money back from the IRS.
Does your product change as time passes?
Most businesses aren’t making the same product, in the exact same way, year after year. This means if your business invests resources to make its own processes, software, or products cheaper, quicker, greener, or cleaner, you probably qualify for this credit.
Benefits of the R&D Tax Credit
Providing startup businesses with tax credits for research and development helps the entire economy because it helps to increase innovation.
Some of the specific ways that businesses can benefit from this tax credit include:
- Receive a reduction in state and federal tax liabilities for the current year and future years
- Increase the businesses cash flow and market value
- Reduces your businesses tax rate
- Allows your business to retain more of its profits
- Use the credit against payroll tax
Related: R&D Tax Credit Guide
How to Use the R&D Tax Credit to Offset Your Payroll Taxes
With the R&D tax credit, there’s a payroll tax credit election. This is offered to qualified small businesses that and the research credit is a set amount. According to the existing parameters, it cannot exceed $250K per year. This credit can be used against the business’s share of Social Security liability.
What Activities Help a Business Qualify for This Tax Credit?
A simple way to determine if your business qualifies for the R&D Tax credit is by considering the “four-part test.” This includes:
- Qualified purpose. The activity’s purpose is to improve the quality, functionality, reliability, or performance of an invention, formula, technique, product, software, or process that will be used in the business or offered for a license, lease, or sale.
- Technological uncertainty. Uncertainty is encountered regarding whether it can or how it should develop the component or the proper design of the component.
- Process of experimentation. To help eliminate uncertainty, alternatives are evaluated by way of systematic trial and error, simulation, modeling, or another method.
- Technological in nature. The failure or success of the evaluative process is determined by principles of “hard” science rather than social sciences or economics.
There’s a common misconception that you must achieve some type of major scientific breakthrough or conduct pioneering or revolutionary research to qualify. However, this isn’t the case. As a result, your business may qualify, and you don’t even realize it.
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IRS Seed Stage Final Thoughts
While it may not seem like it at times, the government has programs to help new startup companies with innovative ideas. If you are unsure if you qualify for the R&D Tax Credit, review the information here or talk to your accountant. You can also learn more by working with professionals in the industry.
Are you ready to see if you qualify for the R&D tax credit? If so, let Taxrobot help. Talk to an expert today to learn more.
Related: Qualified Research Expenses