Introduction to tax credits
The world of tax credits can be a real game-changer for startups. Two credits that deserve your attention are the Employee Retention Credit (ERC) and the Credit for Increased Research Activities (R&D Tax Credit). These credits are designed to put some extra cash in your pocket and give your startup a serious boost.
In this blog post, our main focus will be on helping you maximize the benefits of both ERC and R&D credits. So, let’s dive in and uncover the strategies that will help you make the most of these valuable credits.
The Employee Retention Credit (ERC)
The Employee Retention Credit (ERC) is a refundable tax credit available to employers who kept employees on their payroll during the chaotic times of the pandemic. And specifically, you can claim quarters in 2020 and 2021.
For 2020, you can get back up to $5,000 per employee per year. For the year 2021 on the other hand, there’s a relatively simple provision that now allows you to claim up to 70% of qualifying wages paid up to $10K. This is just a more complicated way of saying you can get back up to $7,000 per employee, per quarter.
Qualification for the ERC is determined by one of three factors:
- You founded a business after February 2020 (this one’s called the Recovery Startup Provision)
- Your business was fully or partially suspended or had to reduce hours due to a government order – either federal or local.
- Your revenue declined by 20% or more in any quarter in 2021 compared to the same quarter in 2020 (or 2020 to 2019).
The Research and Development Tax Credit (R&D)
Unknown to most startups, is that they’re eligible to receive these tax credits for their annual spend on the work they’re already doing to build or improve on their products! And it doesn’t matter if their product is commercially available or if they are making money from it yet.
If your company invests money to make its own products, software, or processes cleaner, greener, quicker, or cheaper, you most likely qualify for the R&D credit!
Some industries that are highly qualified include but are not limited to:
- Artificial intelligence
- Consumer packaged goods
- Cryptocurrency
- Software/Software as a Service (SaaS)
- Manufacturing
- Aerospace
- Virtual reality
- Textiles
- Pharmaceutical
The Difference Between ERC and R&D Tax Credit
Let’s start with a little context. When it comes to purpose and eligibility, the R&D Tax Credit is designed to encourage innovation and technological advancements. It rewards businesses that engage in qualified research activities.
On the other hand, the ERC was developed to support businesses that retained employees during challenging times, particularly the Covid-19 pandemic. Eligible businesses must meet specific criteria related to business operations suspension or significant decline in gross receipts. The ERC focuses on employee retention and aims to provide support to businesses that kept employees on payroll during periods of economic uncertainty.
Additionally, the ERC is a refundable tax credit, which means the government will actually write you a check if there are no taxes to offset. By contrast, the R&D tax credit is a non-refundable tax credit. This means the government won’t send you a refund check, but you can apply the tax credit as a dollar for dollar offset against either your payroll taxes or income taxes so you can keep more cash in your bank account.
Both are super useful in their own ways!
Maximizing Your R&D Tax Credits as a Startup
Maximizing your R&D tax credits as a startup is a must. This credit is one of the most important for startups and can help you boost your company’s bottom line and stretch your runway.
- Understand R&D Tax Credit Criteria: Start by familiarizing yourself with the specific criteria that qualify for R&D tax credits. Identify the activities and expenditures that qualify for R&D tax credits, such as technical research, experimental development, and eligible costs.
- Keep Detailed Documentation: Maintain thorough and accurate documentation of your R&D activities, expenses, and the supporting evidence. This includes project plans, technical specifications, progress reports, meeting minutes, test results, and financial records. Detailed documentation will help substantiate your R&D claims during audits or reviews.
- Identify Eligible R&D Activities: Conduct a comprehensive review of your company’s activities to identify all potential R&D projects that meet the criteria for tax credits. Engage with your technical teams to understand the specific challenges and uncertainties they faced during the development process.
- Collaborate with Tax Experts: Work closely with tax professionals like our friends at TaxTaker who have experience in your jurisdiction. They can help navigate the complex regulations, interpret eligibility criteria, and optimize your R&D tax credit claims. Their expertise ensures you don’t miss out on any eligible activities or expenditures.
- Allocate Costs Appropriately: Accurately allocate and attribute costs to the eligible R&D activities. This includes direct labor costs, prototyping expenses, materials, subcontractor costs, and overhead expenses directly associated with the R&D projects. Ensure your accounting systems capture these costs separately for easy identification during the claim process.
- Make sure you Assess to see if you’re eligible for state Level R&D Tax Credit Programs!
- Stay Updated on Legislative Changes: Monitor any updates or changes to R&D tax credit legislation in your jurisdiction. Tax laws are subject to amendments, and staying informed will help you leverage any new opportunities or regulations that may positively impact your claim.
- Perform Regular Reviews: Conduct periodic reviews of your R&D activities and associated expenses to identify any missed opportunities for tax credits. Engage in proactive discussions with your tax advisors to ensure you are taking full advantage of available incentives.
Maximizing Your Employee Retention Credits
- Understand ERC Eligibility: Familiarize yourself with the eligibility criteria for ERC. In general, businesses must have experienced either a full or partial suspension of operations due to government orders or a significant decline in gross receipts compared to a prior year. Review the specific requirements and guidelines provided by the tax authorities in your jurisdiction to determine if your startup qualifies.
- Assess Employee Retention Period: Evaluate the timeframe during which you can claim the ERC for each eligible employee. The retention period may vary depending on your jurisdiction, but generally, it can span multiple quarters or run until the end of the calendar year. Be aware of any limitations on the number of eligible employees or the maximum credit amount per employee.
- Review Payroll and Employment Data: Gather payroll and employment records for the applicable periods. Ensure that you have accurate and up-to-date information on employee wages, hours worked, and employment status. This data will be crucial for calculating the ERC accurately.
- Calculate Eligible Wages: Determine the eligible wages that qualify for the ERC. Generally, eligible wages include wages and certain health benefits paid to eligible employees during the qualifying periods. Note that the calculation of eligible wages may have specific limitations based on employee counts, salary caps, or other factors. Consult the guidelines provided by your tax authority or seek advice from tax professionals to ensure compliance.
- Coordinate with Payroll and Accounting Teams: Foster collaboration between your payroll, HR, and accounting teams to ensure accurate documentation and reporting. Effective communication and coordination will help ensure that all necessary data is captured correctly, and the ERC is calculated accurately.
- Consult with Tax Professionals: Given the complexity of tax laws and regulations surrounding the ERC, consulting with tax professionals or specialized tax advisors is highly recommended. They can provide guidance specific to your jurisdiction, help you understand the nuances of the ERC, and optimize your credit claims.
Claiming the R&D Credit & The ERC
Businesses can claim the R&D Credit by filing IRS Form 6765, “Credit for Increasing Research Activities. This should be included along with your business tax return (e.g., Form 1120 for corporations, Form 1065 for partnerships).
As part of this process, they need to identify their qualifying expenses and provide adequate documentation that shows how they meet the requirements.
Businesses can claim the ERC by filing an amended Form 941 with their federal employment tax return. This form is typically filed quarterly, and you can amend previous filings to claim missed credits.
The Bottom Line on these Tax Credits
As you can see, both ERC and R&D tax credits can create significant savings for your business and should be claimed if your business is eligible.
We know this stuff is complicated and are here to support you, which is why we’ve partnered with our friends at TaxTaker to support tax credit analysis and claims. They’ve saved their clients more than $30 million between these two programs and are here as a trusted resource.
Want to set up a free call with them to see if you qualify?
Should you have questions or need assistance, give us a shout!
