THE APRIL 18TH TAX DEADLINE IS APPROACHING FAST
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The research and development (R&D) tax credit is tax legislation passed to incentivize American companies to invest in innovation.More than $12 billion worth of R&D tax credits were claimed in 2014, but a significant portion 0of that money went to Fortune 500 companies. Congress has taken specific action of the last half-decade to make sure the credit is available to early-stage startups. The goal is to give innovative startups the tax credit they need to create new, valuable ideas in the United States.
If you’re a startup in the tech space, you more than likely qualify for the R&D Tax Credit. The qualifications for the credit are:
Importantly, in order to use the R&D Credit towards your payroll rather than your income, you must also fit these 3 criteria:
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The 2016 expansion of the R&D Tax Credit allows startups to claim the credit against their payroll tax for up to 5 years. Each year, they can receive a maximum credit of $250,000, so theoretically, a company could receive a maximum of $1.25 million over their first five years.
First, the tax code is purposely obscured. Second, the R&D Tax Credit didn’t apply to startups like yours until 2016. The newness of the law means many companies are leaving money on the table. But, we’re here to help. neo.tax’s automated filing system can complete the process for your company in less than 15 minutes. We take just 5% of your savings and only after they arrive in your bank account. The R&D Tax Credit was written for startups like yours; get the money that you’re owed.
When Ronald Reagan signed the Economic Recovery Tax Act of 1981 into law, businesses quickly jumped to take advantage of the new tax break that let them lease or rent computers. At the time, computers were prohibitively expensive, which made them impossible to own for all but the largest corporations and research institutions. Instead, most people leased time on mainframe computers. The 1981 bill made it so the money companies spent leasing mainframe computers were Qualified Expenses towards a tax credit. While the bill was built to democratize access to computers in the business world, it ended up becoming most valuable for the largest companies. In a section of The Protecting Americans From Tax Hikes Act of 2015 (PATH), congress set out to fix that issue. For years, the R&D tax credit could only be used to offset a company’s income tax. Obviously, most early-stage startups don’t have any income to offset. So, starting in 2016, in order to incentivize innovation at the early startup level, the PATH Act allowed early startups to use the R&D Tax Credit towards payroll tax as well. That law made thousands of startups newly eligible for the R&D Tax Credit; unfortunately, most still don’t realize or have the resources to file for the money they’re owed.
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For years, we’ve been working to make sure innovative companies claim the money they’re owed via the Federal R&D Credit. It’s never been more important to extend runway, and claiming your credit is the best way to secure non-dilutive capital.
But even as we’ve watched the Federal R&D Credit become more widely known by founders and CFOs, many innovative companies still aren't aware that 38 states offer an additional State R&D Credit for companies. This is tax law built specifically to incentivize innovative companies like yours to, well, innovate. Not claiming it is just leaving money on the table…
Like the Federal R&D Tax Credit, many states have a state-specific R&D credit to incentivize innovative companies to create jobs and products within their state. Currently, 38 states offer specific R&D credits — each differs slightly, but many follow similar frameworks to the Federal R&D Tax Credit when it comes to Qualified Expenses and deadlines.
As of 2023, 38 states offer their own R&D Tax Credit in an effort to incentivize job creation, and as a means to stimulate the local economy. Those states are:
Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Mississippi, Nebraska, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Ohio, Oregon, Pennsylvania, Rhode Island, South Carolina, Texas, Utah, Vermont, Virginia, Wisconsin.
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While each state has different rules on which expenses qualify, what type of companies can file for the credit, and how much the credit is worth, it’s always valuable for a company to claim every R&D credit they’re owed. Go to Neo.Tax and we can help calculate how much you’re owed and help you prepare your R&D tax credits today!
To give a sense of how valuable these credits can be, we wanted to share a case study of a California-based company that used Neo.Tax to claim both the Federal and State R&D Credit. For any research and development done within the state of California, the California State R&D Credit is equal to the sum of: 1) 15% of qualified expenses that exceed a base amount + 2) 24% of basic research payments.
A Series A IT Management Software Company approached Neo.Tax to help with their R&D Credit filing. With a revenue of $1.5M and $9M in expenses, the rapidly growing startup was able to claim $150,000 via the Federal R&D Credit. And how much more could they claim via California’s State R&D Credit? $50,000!
That extra $200K in their coffers was a game-changer during this precarious economic moment. And all it took was reaching out to Neo.Tax. As founders know, there’s almost no such thing as free money. But this credit was built by Congress and by 38 states to incentivize innovation within their borders. So, the money is available to innovators. All you have to do is claim it.
Book a call with an expert at Neo.Tax and we’ll walk you through the entire process. It’s easy and takes less than 30 minutes. So, what are you waiting for?
When Sachin Sood was in college at UC Irvine, a friend asked him what he planned to do with his economics degree. In retrospect, Sachin now knows, “You can’t do s*** with economics, quite frankly, unless you’re an East Coaster who wants to go into banking,” but as a 20-year-old college student, Sachin responded confidently. “I said, ‘I want to be a CFO,’” he remembers, grinning. “No joke.”
In the two decades since graduating, Sachin has taken a winding path to the CFO chair at CRV, the venture capital firm that invests in early-stage enterprise and consumer startups. “Now, did I know what CFO meant while at UC Irvine? Hell no. I had no idea what a CFO was going to do at that point,” Sachin says, laughing. “And now, in retrospect, it's completely different than I ever anticipated. But I knew I wanted to go down this route.”
Like most career paths, the route only looks linear when seen through the rearview mirror. “Economics went into tax when I took the job at PwC. Tax went into a finance operational role when I was a controller, and that actually ended up changing to more global thinking and finance models at e.ventures,” he explains. “And Social Capital was a completely different mold altogether.”
Since entering the workforce in 1999, Sachin’s “done a little bit of everything.” As he explains it: “For me, it's been hop, skip, jump.”
Sachin credits a lot of his success in investing and venture capital to his time working on the tax side early in his career. He began at PricewaterhouseCoopers (PwC) as an associate before moving to the role of Tax Manager at Delloite and Controller at Saints Capital. Those 8 years getting deep on tax allowed him to understand the foundational aspects of alternative investments such as venture, private equity, and hedge. “Taxation is the fundamental basis of a lot of what we do, especially in venture,” he says. “When government creates a tax credit, you'll see more money going into that type of business because companies know there's a tax incentive behind it. So, tax drives a lot of what we do. People just don't notice it sometimes, but it's critical.”
While so much of the focus for pre-IPO companies is on valuation, those numbers are projections for shareholders. Taxation at the time of an IPO is the tangible reality for a VC firm. “People will mark up portfolios and down portfolios in this market, but it doesn't mean anything,” he says. “At the end of the day, it's all about when you exit, what price do you exit, when do you sell it at, what do you IPO at? You want to ensure that when there is an IPO window and there is an exit, it's structured properly to give the best tax structure.”
His background in the fundamentals of economics and his years on the tax side has allowed him to remain laser-focused on the tangible reality. It’s the superpower that’s allowed him to thrive in his role as CFO. “I had an economics background. I went to work at a tax firm. I did portfolio management at Saints; a lot of it. And then I went to Social, where I did a little bit of everything, including working as a CCO at a RIA and sharpening legal skills,” he says. “Now, I’m in a role where all the skill sets are needed.”
Over the last seven years, Sachin has been on the finance side at the global investment fund e.ventures, at Social Capital, and now at CRV. His time as VP of Finance at the two former companies and as CFO at his current company has allowed Sachin to dive deeply into the wide breadth of leadership styles across the tech world. “The investment side is all about learning,” he says. “At times, it's not just about one business that you learn; instead, you have to figure out how that business works across the different companies that focus upon. Each sector is so different. It's so nuanced.”
But from his bird’s eye view, he’s identified what he likes to call “the five types of CFOs.” First, there’s the startup CFO, who is involved across many different slices of the company and must be a master of shareholder desires, cap tables, and much more. Next, there is the small-business CFO, who has to have a mastery of all that but also have a specialty that is specific to the company’s focus. The medium-sized CFO who takes on the role of scaling the business — they are a strategy specialist. “Then you'll have a division CFO at a public company, and finally the public company CFO,” Sachin explains.
“What we end up seeing is, in the early stages of the company, you usually won't hire a CFO. You will hire an external firm to help you scale. You’ll hire a CFO when you have the breadth and the vision and when you have scale. The best way to say this: you have revenue, at that point, you bring the CFO,” Sachin says.
But how do you select the correct CFO for your growing business? “It really depends on what the CEO of the firm is looking to do,” he says. “If you're looking at an exit, you're bringing someone a bit more strategic. You're bringing a banker who has a better understanding. And then if you're looking for an IPO, you bring in somebody who actually understands the business in the long run.”
The real key is for both the CEO and CFO to understand the job of the Chief Financial Officer. “Quite frankly, a CFO’s job is just to know facts. At the end of the day, I always explain: ‘I present facts; it's up to you to make a decision,” he says. “If you want my opinion, I'm happy to provide it because I always have an opinion. But first I present the facts. This is what you're spending. This is what the org is struggling with. This is where costs are compared to our competitors. Ultimately, those choices get brought up to the CEO and then eventually a board member.”
When Sachin first started as CFO at CRV, people kept asking him why he was always reading. He explained that to do his job well, he needed to dive deep into the weeds to fully understand as many aspects as possible of the core business. But now four years into his role, he’s come to understand the power of delegation. “It was really tough for me to be strategic because I knew I first had to learn the core business,” he says. “That’s why you have to rely on another partner. You have to rely on your controller. You have to rely on various controllers or people that are specialists.”
Today, Sachin works closely with two controllers: one who is a tax specialist and the other who is a portfolio analyst who is a data analyst. Each controller can focus full-time on their specialties, ensuring every aspect of their slice of the business is perfectly in order. “I have people that specialize in specific components because I can see the value of having experts in the weeds,” Sachin says. “They're going to be better at that than I am, quite frankly.”
Because Sachin worked in a controller role earlier in his career, he respects the value of great controllers. “It’s rolling up your sleeves. It’s ensuring the fact that your books and accounting records are in place, so there are no surprises at the end of the day,” he says. “They can allow the CFO to focus more on strategy, on thinking ahead, on tax savings, on thinking about how your portfolio is affected, and what the CFO can do to help out your portfolio companies. A great controller opens up a CFO’s mind to do more deep, strategic thinking.”
We aren’t breaking news to tell you that the language of taxes is remarkably obscure. There are tax code numbers, endless terms, numerous IRS tests, and so much more, which all become extremely important on Tax Day.
You’re not an accountant, but for founders, CFOs, and CEOs, understanding the language of taxes can help you strategize from a position of strength. So, we’re proud to present “The Language of R&D Taxes, Translated”, a helpful cheat sheet from your friends at Neo.Tax :)
Capitalization - capitalization can be understood as a limitation on the timing in which you can take a deduction. There are two different subgroups of capitalization: depreciation (for physical assets) and amortization (for intangible assets).
Deduction - a deduction can be thought of as an expense that is subtracted from taxable income. So, if you made $10 mil in revenue and spent $5 mil on R&D, deducting that amount would make your taxable income $5 mil ($10,000,000 minus $5,000,000).
Doing Business As (DBA) - a DBA is a name other than one’s legal name that a person or company does business under.
Employee Identification Number (EIN) - a nine-digit number assigned by the IRS, used to identify taxpayers who are required to file various business tax returns.
NOL - a Net Operating Loss means how much in the red you are in a given tax year. So, if your startup is pre-revenue or early-revenue, every dollar you spend on payroll, marketing, R&D, or rent over the amount brought in via sales would be counted as an NOL.
Unused NOL - if the loss is not fully used up in the carryback years, any unused portion of the loss may be carried forward for up to 20 years after the NOL year. Any NOL that is not used up in the carryover period is lost.
Taxable Income - the portion of your gross income that's actually subject to taxation. Deductions are subtracted from gross income to arrive at your amount of taxable income.
Total Expenses - The cumulative sum of expenses from your accounting and payroll systems.
R&D Credit - enacted in 1981 to encourage research and development (R&D) activities in the United States, the R&D tax credit reduces tax liability for organizations that perform certain activities to develop new or improved products, processes, software, techniques, formulas, or inventions. You can get about 10% back on qualifying expenses such as wages, contractor costs, cloud hosting and infrastructure, supplies, and legal costs.
Expenses allocated to R&D - direct expenditures relating to a company's efforts to develop, design, and enhance its products, services, technologies, or processes.
Qualified Expenses - these are the expenses covered by IRC Section 41. They are the expenses eligible to be claimed as part of the R&D Tax Credit (they must pass the IRS’s 4-Part Test to qualify), such as:
The 4-Part Test - for an R&D expense to qualify for the R&D Tax Credit, it must pass the IRS’ 4-Part Test. It must:
New or improved business component (product/process) - the first part of the 4-Part Test: The research must be focused on developing a new or improved business component for the company. A “business component” means any product, process, computer software, technique, formula, or invention held for sale, lease, or license or used in a trade or business. This can include improving the function, performance, reliability, or quality of an existing product or business component.
Technological in nature - the second part of the 4-Part Test: The research relies on principles of the physical or biological sciences, engineering, or computer science, including software development.
Attempts to eliminate uncertainty - the third part of the 4-Part Test: The research aims to eliminate uncertainty concerning the development or improvement of a business component. For example, the method or appropriate design is not apparent and not readily found in the public domain. Essentially, an uncertainty can be “How can we develop this new application?” or “Could this material make our product lighter without sacrificing durability?”
Process of experimentation - the fourth part of the 4-Part Test: The research must be a process of evaluation and generally should involve comparing alternatives looking for the best solution. This includes the iterative trial and error process inherent in version-controlled software development.
Non-qualified R&D (IRC Section 174) - these are R&D expenditures that DO NOT qualify for the R&D credit:
Deductible R&D - In years prior, companies were permitted to deduct R&D expenses in the year they were incurred. Beginning in tax year 2022, that is no longer the case. Instead, you are now required to amortize those expenses over five for domestic R&D or 15 years for foreign R&D.
Foreign R&D - R&D performed abroad by U.S.-located companies.
R&D Capitalization - as part of the TCJA, you can now only deduct a fraction of total R&D expenses. That means companies may now find that they have a taxable income, even through they are not yet profitable. The graphics below highlight this point:
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Before these changes were written into law, 100% of your R&D spend could be deducted from your income. If you brought in $1M in revenue and spent $2M on R&D to develop your innovative product, you would end the year with $1M in Net Operating Losses (NOLs). Now, you have to spread the R&D deduction over 5 or 15 years depending on if the spend is made in the United States or abroad—this is called amortization. Worse than that, only 6 months of the first year of R&D spend can be deducted. So, if the $2M you spent on R&D is domestic, you’ll only have $200K to deduct from your $1M.
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