Boost Your Portfolio with the R&D Tax Credit

Boost Your Portfolio with the R&D Tax Credit

Posted by Shaun Yeh, Esquire on 09.11.19

Whether you are an Angel Investor or Venture Capitalist (VC), you are not only helping finance, you are also advising and adding value to any business or start-up you invest in. As an investor, you should be knowledgeable of the R&D tax credit and its value as a powerful source of funding that can boost your portfolio and give you the added edge over your competition.

Each year the U.S. government provides billions of dollars to American businesses for developing new or improving existing products, processes, and techniques under Internal Revenue Code Section 41. The federal government implemented these tax credits for research and development in 1981 to create jobs and spur business growth in the United States. Known as R&D tax credits, the program was initially meant to be a temporary measure to stimulate the economy. It has since been made a permanent tax credit.  While many investors are aware of the tax-saving potential offered by the R&D tax credits, not every firm has the time, resources or expertise to take on the application and documentation process. The activities your clients conduct on a regular basis may qualify for these valuable R&D tax credits. These tax credits represent a significant financial advantage to businesses in a wide range of industries, reducing tax liability and allocating cash back for reinvestment or other needs. 

The R&D tax credit has existed for multiple decades, but one major obstacle for startup companies used to be that the credit was initially designed to be applied against  a company’s income taxes.  As startups are not usually flush with revenue, there used to be a common scenario where a startup company could have generated and claimed a credit, but the company might not have been able to see any benefit from the credit.  The company might have been pre-revenue and thus did not have an ability to utilize the credit against taxes.  

Congress remedied this situation for most startup companies at the end of 2015. As a part of the Protecting Americans from Tax Hikes (PATH) Act of 2015, startup businesses with gross receipts of less than $5 million could claim the R&D tax credit against their payroll taxes, substantially making it a refundable credit for up to five years. Beginning in 2016, the new payroll tax offset allowed startup companies to receive a benefit for their R&D activities regardless of profitability. The maximum benefit an eligible company can claim against payroll taxes each year under the new law is $250,000. 

Additional Items to be considered a “Qualified Small Business”?

  • Company has gross receipts for fewer than five years. 
  • 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.
  • Business is not a tax-exempt organization under section 501.

Activities Must Meet A Four Part Test

It can be challenging to navigate through the complexities involved with qualifying for the R&D tax credit and develop the necessary documentation. For example, to be eligible, an activity must meet a four-part test embodied in Internal Revenue Code Section 41. A knowledgeable R&D tax credit expert can help determine which activities qualify and help you with the required documentation.

The 4 Part Test:

            1. Qualified Purpose - The purpose of the research must be to create a new or improved product, process, or formulation, resulting in increased performance, function, reliability or quality. 

            2. Technological in Nature – The research must rely on the hard sciences, such as engineering, physics, chemistry, biology or computer science. 

            3. Elimination of Methodology or Capability Uncertainty – Activities must overcome some technical challenges that involve optimal design or methodology or create capability uncertainty 

            4. Process of Experimentation – Experimentation can be demonstrated through test batches, simulations, systematic trial and error, or other methods of evaluating alternatives to achieve a desired result. 

The R&D tax credits are a powerful source of funding for startups and the investors that support them. By getting to know the businesses you invest in, investors can set goals and advise necessary plans either to accelerate growth or secure additional funding. If you’re an investor or a growing business trying to attract investors, then you cannot ignore the R&D tax credit. Many of the activities you or your clients are already performing on a daily basis can qualify for R&D credits. R&D tax credits present an outstanding opportunity to offer your clients a value-added service. By partnering with an R&D expert like Tax Point Advisors, you can offer the service without burdening your staff with time-intensive documentation. 

Tax Point Advisors assists CPAs, investors and their clients in identifying and capturing their optimal federal R&D tax credits, as well as state R&D tax credits. For more information, contact us at (800) 260-4138, or leave us a message below.


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