As a startup, you’re probably looking for every money-saving opportunity you can find. That’s particularly true when it comes to your taxes.
Even if you’re operating at a loss and don’t have a tax liability yet, tax credits matter. The U.S. Code allows you to carry those forward for up to 20 years, which means things you’re doing today can go a long way toward shrinking your tax bill in the future.
Take, for example, the credit for increasing research activities, commonly called the R&D tax credit. You can apply a percentage of what you spend on qualified research expenses (QREs) to this credit — to the tune of up to $500,000.
Those QREs can be supplies and money you pay to outside researchers, but they can also be wages you pay to your own team. In other words, the money you’re already spending might help you claim this credit.
To help you get a feel for which paychecks might count as QREs, let’s look more closely.
Understanding which roles qualify
Your research credit equals 20% of your QREs over what the IRS calls a base amount. This can get a little complicated, but we explored it more here.
We’re not necessarily here to crunch those numbers, though. First, let’s figure out what you can count toward QREs, potentially getting 20% of that money back in the form of a tax credit. For that, we’re going to break down the applicable portion of the Internal Revenue Code (IRC).
Let’s get started. Something can count as a QRE when it’s an in-house or contract research expense. With in-house employees, 100% of wages you pay that person to engage in qualified services can count toward your credit total. With contractors, 65% of those paid wages count.
Qualified services can mean either:
- Engaging in the research itself, or
- Engaging in the direct supervision or support of that research
That means that even a portion of your C-suite executives’ salaries might count, as long as you carefully track how much time they spend in meetings that pertain to qualified research.
So, what counts as qualified research? It needs to meet four criteria. To qualify, research needs to be:
- Aimed at discovering new information
- Technological in nature (i.e., use hard sciences, not social sciences)
- Used to develop a new or improved business component
- Undertaken under a process of experimentation
The part of the IRC that we’ve just gone over specifically calls out things that don’t qualify as QREs, too. Those include surveys and studies and adapting a product or service to a customer’s specific requests.
In other words, this can get pretty granular. Talk with your accountant and they can help you identify work at your startup that counts as qualified research activity.
Job titles that might count
While your accountant can help you get a good feel for what salaries, hourly wages, and payments to contractors might count as QREs, we can help you get the ball rolling right here and now. Here are some job titles that often qualify for the R&D tax credit:
- Alpha or beta testers
- Chief technology officers
- Computer programmers
- Data scientists
- Designers (as long as the design work involves iterating and leverages hard sciences)
- Engineers, including:
- Application engineers
- Automation engineers
- Civil engineers
- Computer engineers
- Design engineers
- Electrical engineers
- Mechanical engineers
- Project engineer
- Software engineers
- Structural engineers
- Production managers
- Process technicians
- Quality assurance personnel (on a case-by-case basis)
- Software developers (as long as the software is used for external, not internal, purposes)
Remember, too, that engaging in the supervision or support of the research work counts. So if your CTO has an assistant and they spend a portion of their work week writing up notes from research-focused meetings, those hours may apply.
Or say you have a team of software engineers managed by someone who has other responsibilities. The hours that manager spends supervising the computer software development probably count as qualified research activity. That means the money you pay them for those hours can likely apply toward your credit.
Recordkeeping to claim the credit
As with just about anything when it comes to the IRS, a paper trail is key. Fortunately, tracking the amount you’re spending on wages is usually fairly easy. If you’re using payroll processing software, you should be able to pull a report for the salaried and hourly employees engaged in qualified research activities.
Similarly, you probably have good records for any amounts you’ve paid to contractors.
But this all assumes that these employees and contractors are spending 100% of their workday on qualified research activities. Often, that’s not the case. Your company needs to develop a process to figure out how much of their time is going toward research. Our team can help you develop what you need here to keep tabs on those hours — and count them toward your credit.
You can’t stop there, though. There’s another piece of the recordkeeping process. In addition to the amount your startup has paid out, you also benefit from keeping proof of the research activities themselves. If you ever get audited, you’ll need a way to substantiate that research.
Fortunately, your team probably already produces documentation you can use here. Meeting notes, testing and debugging reports, software process documentation, and assets like these show the IRS that you’re engaged in research-based work.
Again, we can help you identify documents to hang onto in the event of an audit. Then, most startups either tag them in their internal storage system or file a copy in a separate folder. That way, if the IRS ever does come knocking, you just need to call up all of that proof to substantiate your claim to the credit.
Ultimately, yes, recordkeeping for the tax credit for increasing research activities isn’t easy. But since it can help you slash your tax bill by up to a half-million dollars, it’s worth it. Plus, we’re here to help.
We’re experts in supporting startups with their taxes, and we specialize in the R&D tax credit. If you want to learn more about which people you’re already paying could help you claim this tax bill shrinker, contact our team.