How Arizona startups can get $250,000 from the IRS for their R&D

July 29, 2017

Each year the US government provides billions of dollars to innovative businesses for developing new or improving existing technologies, products, materials, and processes, under the US Research & Experimentation Tax Credit (R&D Tax Credit) program.

The program has been around since 1981. Previously, the program would periodically expire and be renewed by Congress. Businesses wishing to include this in their long-term budgeting plans couldn’t count on the credit being around for certain. In 2015, the Congress made the R&D tax credit permanent as part of the Protecting Americans from Tax Hikes (PATH) Act of 2015 and also made key changes so that more businesses could benefit from the credit.

Historically, businesses that were not paying federal income taxes could claim R&D Tax Credits, but would need to carry them forward on their corporate and/or shareholder returns until they could offset their income tax liabilities. This made it difficult for startups or businesses that weren’t profitable to benefit from the credits.

With the new changes, startups can apply the R&D tax credit against the employer portion of social security taxes up to $250,000 for each fiscal year. The new payroll tax offset allows qualified small businesses to receive a benefit for their research activities regardless of profitability.

What is a qualified small business?

1.    A business that has gross receipts of $5 million or less for the tax year.

2.    Has gross receipts for five years or less. The business must not have gross receipts for any tax year before the 5-tax-year period ending with the tax year they’re applying for. For example, businesses that have generated gross receipts prior to 2012 are not eligible to claim for the 2016 tax year.However, businesses that existed prior to 2012 but didn’t receive gross receipts could still qualify. Although the law is intended to benefit small businesses, larger businesses could also benefit from the rules as they’re written. For example, a significant percentage of life science companies have zero gross receipts for long periods of time until their drug receives U.S. Food and Drug Administration approval.

3.    Is not a tax-exempt organization under section 501.

What work qualifies for the R&D tax credit?

Qualified research is work intended to achieve an innovation within a scientific or technological field. The R&D efforts must pass a 4-part test in order to be eligible:

1.    New or improved business component: the work must be done to develop a new or improved product or process.

2.    Technological uncertainty: the work must be done in order to resolve technological uncertainty. A technological uncertainty exists if publically available information and knowledge cannot be applied to achieve the desired result.

3.    Systematic process: the work must be done in a systematic process to evaluate one or more alternatives to achieve the desired result.

4.    Technological in nature: the work must be within the physical or biological sciences, engineering or computer science.

How do I use the R&D tax credits to offset my startup’s payroll taxes?

The payroll tax credit election is an annual election made by a qualified small business specifying the amount of research credit, not to exceed $250,000, that may be used against the employer portion of social security liability. It is available for qualified expenses incurred in the 2016 tax year and after. If a business receives more than $250,000 in R&D tax credits, the remainder can be carried forward to offset payroll taxes or reduce taxes owed in future years.

Companies are required to pay Social Security tax of 6.2% on up to $118,500 of each employee’s salary. This means a company that employs 40 employees with an average annual salary of $100,000 per person would pay approximately $248,000 in Social Security payroll taxes in 2016.

You can first claim the qualified small business payroll tax credit for increasing research activities on the Form 941 for the quarter that begins after you file your income tax return. Form 941 is a quarterly statement used to report any withheld taxes from an employee’s paychecks and/or to report payment of the employer’s portion of Social Security or Medicare tax.

For example, if you file your 2016 income tax return based on a calendar year (January 1 – December 31) on March 15, 2017, the 2017 second quarter (April 1, 2017– June 30, 2017) Form 941, which is filed by July 31, 2017, is the first quarter that you can take advantage of the credits.

What are the deadlines to claim?

The R&D tax credits must be specified, elected, and filed on the original tax return before you can begin to offset payroll taxes.

For C Corps with a December fiscal year end, the deadline to claim is April 15. For C Corps with fiscal year ends other than December, the deadline to claim is 3.5 months following the end of the tax year.

For S Corps with a December fiscal year end, the deadline to claim is March 15. For S Corps with fiscal year ends other than December, the deadline to claim is the 15th day of the 3rd month following the end of the tax year.

You can also request a 6 month extension on your taxes which automatically applies to the R&D tax filing as well. Additionally, there is a one time exception for fiscal year 2016 allowing you to file by Dec 31, 2017.

How much of my startup’s R&D costs can I recover?

Federal

The federal credit is 6% of eligible expenditures or 14% of half of the average R&D expenditures over the past three years – this may yield a much higher credit (it results in a 10% credit for first time claimants or claimants with consistent expenditures over a three year period).

The Federal portion can be used to offset social security taxes owing up to $250,000 per year. For example, a startup with $500,000 of eligible software engineering expenses, could credit $50,000 or more, while a company with over $2.5 million in eligible expenses in 2016 could have a credit subject to the full $250,000 annual limitation. If the credit amount exceeds a company’s social security tax (OASDI tax) liability in any given quarter, the excess will be carried forward to the next calendar quarter.

Arizona

The Arizona state credit is 24% of the first $2.5 million in qualifying R&D expenses plus 15% of the qualifying expenses in excess of $2.5 million.

Businesses can get 75% of the state R&D tax credit as a cash back (minus the current year’s tax liability). If you elect to get the refund, you will need to forfeit the remaining 25 percent credit and pay a modest 1 percent of the refund as a processing fee. To qualify, you need to employ less than 150 people in the tax year and you need to file a Certification of Qualification with the ACA.

The ACA has been given the authority to approve refunds under the state R&D tax credit program for up to $5 million in any calendar year. Therefore, refunds are approved by the ACA on a first-come, first-served basis, according to the date and time an application is filed with the ACA.

Does my startup qualify for R&D tax credits?

Here are a few questions that you can use to determine whether the work you’re doing qualifies:

?     Are you involved in engineering, design, data collection, testing or other developmental work?

?     Have you designed or developed new software?

?     Have you changed a process to reduce costs?

?     Have you created a new product, made improvements or added new features to an existing product, or built a prototype?

?     Have you incurred costs related to a process, project or prototype that is incomplete because of unresolved technical problems?

If you’ve never claimed the R&D tax credit previously either because you didn’t think you qualified or you couldn’t use the credits, it’s a great time to reconsider.

If you have any further questions, visit https://info.boastcapital.com/blackdog for a complimentary no-obligation assessment and mention Black Dog Ventures for a special rate. Boast will go through your project(s) in more detail, tell you what qualifies and what doesn’t, and provide an estimate of your potential returns.

This is a guest blog post from Lloyed Lobo, Cofounder & CSO of Boast.AI.

Since 2011, Boast has been helping innovative businesses in the US and Canada recover their R&D costs from the government. Boast’s AI-driven software and experts—engineers and accountants with over 25 years experience—handle your R&D claims on an ongoing basis to ensure nothing is missed, all the supporting documentation is in place in the event of an audit, and your claims are compliant and maximized. For more information, visit https://info.boastcapital.com/blackdog

Scott Kelly, CEO Black Dog Venture Partners

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