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How R&D tax credits can help startups avoid cash burn

Aug 24, 2020

The COVID-19 pandemic has fundamentally changed the landscape, and startups with an eye on scaling up, in particular, are deeply impacted since they operate with lean teams and resources, and far less cushion than a scaled enterprise.

Most early stage startups have limited funds and their situations aren’t expected to improve in coming months.

It’s not enough to reset their cost base with more focus and avoid cash burn. Startups need to think strategically about the future and manage cash burn while identifying new revenue sources. While government support packages such as PPP and favorable loan terms have been popular, there are other ways of getting capital to cash-strapped companies when they need it most.

Research and development (R&D) tax credits are a great opportunity to inject cash into startups when the government funds start to wind down.

The R&D credit provides an incentive for companies to invest in innovation in the United States. While the traditional definition of R&D may include white lab coats, the tax definition is much broader.

Any time a business makes changes or improvements to a product, design or development process, the related activities could be earning the business tax credits. In order to claim the R&D credit, startups must have:

  • Current tax year gross sales less than $5 million
  • No gross sales 5 years prior to current year

Companies that qualify can claim certain wages, supplies, and contract research costs associated with R&D projects and activities.

Since the R&D tax credit is a nonrefundable credit, startup companies are frequently limited in their ability to claim it in the current tax year because they have net operating losses.

Although the startup is yet to see a lot of taxable income, they have incurred significant costs, including payroll taxes. The federal R&D credit can be used to offset the employer’s portion of payroll taxes, giving a substantial cash benefit to innovative start-up companies. Up to $250,000 of payroll taxes can be offset each year.

In addition, many states also have their own research credit, but rules may be different since not all states follow the federal rules.

This offset to payroll taxes may provide a significant cash flow opportunity for small businesses and start-up companies that do not have federal income tax liability to otherwise offset the credit.

How Wipfli can help

Wipfli’s team dedicated to serving startups can help you scale up your business with our strategic and financial advisory services. We also have solutions for cloud operations, custom software development and virtual CFO services, among others.

To see how our team can helps yours, see our web page for startup companies.

For additional information on how to respond, recover and revitalize your business in the aftermath of COVID-19, see our crisis response center.

Author(s)

Ronald O. Bote, CPA, MST
Manager
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