Research and Development Tax Credit for Startups

Research and Development tax credit is available to every business having qualifying research activities. The number of years in business matters (to calculate base period) but that does not mean startups are not eligible to claim R&D tax credit. In fact, most startups perform quite a bit of research that helps them qualify and benefit from research and development tax credit.

Let’s take a look at some of the rules that will help startups to take benefit of the R&D tax incentive.

What Is a Startup?

A startup is generally thought as an entity in its first few years of business. The R&D credit rules describes historic companies and non-startups with QREs and gross receipts

· in a tax year that started on or before 12/31/83

· during three of the four tax years starting from 1/1/84 and ending 12/31/88

Any company that does not fall under this category is considered as a startup. Hence, there is no reason why startup owners should not apply for the R&D tax credit. In some cases, the startups would not be able to get the immediate benefit if they don’t have any current year tax liability or less or no income. However, there are provisions in R&D credit laws that allow startups to carry forward their tax credits for a period up to 20 years.

What Benefit Has PATH Brought to Startups?

The R&D credit was created in 1981. It expired and was reintroduced several times until the Protecting Americans from Tax Hikes (PATH) Act of 2015 made it permanent. Before the introduction of PATH, the R&D tax credits could be only used against Federal taxes. This condition prevented small companies and startups who paid Alternative Minimum tax (AMT) from getting benefit from R&D tax incentive.

The new provisions brought in important changes as eligible small businesses and startups could use the R&D credits against AMT. In cases where there is no income tax liability, startups can use the tax credits against the payroll tax. These provisions are applicable since 2016 and the PATH Act of 2015 allows startups to use all tax credits, use part tax credits and carry forward any used tax credits up to 20 years.

Potential Tax Savings for Startups

Startups and eligible small businesses can use the tax credit up to 100% to reduce the income tax liability for years in which they paid AMT. An allowable tax credit for a tax year considers different factors such as evaluation of net income tax, AMT, net regular tax liability, tentative minimum tax, and limitations.

Startups can utilize the tax credits to offset the payroll taxes up to $250,000 every year. The tax credit ( can be applied against OASDI (old age, survivors, and disability insurance) tax liability paid for the employee every year.

The OASDI liability is around 6.2% of the gross salary of the employee’s earnings and it can go up to $118,500 for an individual employee. Thus, the startup owner can make huge savings by using the tax credits against payroll taxes.

How Quickly the Startup Needs to Act on This?

The opportunity to offset payroll taxes is based on 2016 expenses. Hence startup founders should act fast to determine their eligibility. The best way to start is planning in the current year, so you have the information about what you are required to gather by the time of the filing.

Under the current rules, businesses are not allowed to take the opportunity of offsetting payroll taxes on amended return. This means the credit should be filed and specified on the original 2016 return before you begin to offset payroll taxes in the year 2017.

The payroll taxes offset option is available for startups up to five years and any unused tax credits can be carried forward and used when the startup becomes profitable. Startups who outsource their research to the third party can also claim for R&D credit for payments made to the contractors.

Looking at the new provisions, it is clear the research and development credit scheme has a lot to offer to startups. Going by the new laws, unprofitable startups will have more funds in hand to develop new and improved products and stay in the race.