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Tax law is rarely popular, especially with both sides of the aisle. But the R&D tax credit has done the unthinkable: change the tax code to appeal to everyone, by incentivizing innovation within the United States. Every 1-2 years since it was created in 1981, the R&D tax credit has been extended with a congressional rubber stamp. And, in 2015, with the passage of the Protecting Americans from Tax Hikes (PATH Act), the R&D credit became permanent law.
But then, just two years later, Donald Trump signed into law his landmark Tax Cuts and Jobs Act (TCJA). The Congressional Budget Office—tasked with nonpartisan analysis of the TCJA, which included a new single corporate tax rate of 21% (down from 35%)—found that the new tax code would vastly increase the national deficit between 2018 and 2028. So in an effort to recoup some of those lost taxes, Congress modified the TCJA to include a massive change to the way R&D expenses are treated, which goes into place next year. And, unfortunately, this change is very, very bad for startups. (Even after this amendment, the CBO still found that the TCJA would increase the deficit by nearly $1.9 trillion.)
As Washington Post columnist Catherine Rampell explained: “To help make their corporate rate cuts as large as possible, Republicans included some measures that would (ostensibly) raise a little bit of money to offset the cost. Among these supposed pay-fors was this change to the tax treatment of R&D spending.”
That change is an amendment to IRC §174: starting next year, Research and Experimental (R&E) expenditures incurred or paid for tax years beginning after December 31, 2021, will no longer be deductible for tax purposes. Instead, American businesses investing in R&D will have to capitalize and amortize expenditures over a five-year period for research conducted within the U.S. or over 15 years for research conducted abroad.
Capitalization and amortization effectively slow down the deductions for R&D (and REALLLLY slows them down for foreign research), which means that when the rule first goes into effect, companies will have fewer deductions and more taxable income in earlier years. Theoretically, they will eventually be able to deduct all costs, but why slow this process down?
Why? It seems likely it was a budgeting trick. The 2022 R&D capitalization rule was a (wildly unpopular) part of the law that was passed to cut corporate tax rates, because when the Congressional Budget Office "scores" legislation, they look at the budget impact over 10 years. Thus, the giant deficit created by dropping the corporate tax rate to 21% was partially masked by the increased revenues from this 2022 capitalization provision. Tax cuts appeared to only create a $1.4 trillion deficit, when in fact it would be much larger without the R&D capitalization provision.
“The presumption at the time was that these provisions might never materialize because future Congresses would step in and reverse them first. One of the architects of that 2017 GOP tax overhaul, Rep. Kevin Brady (R-Tex.), even publicly and repeatedly endorsed proposals to undo his own handiwork,” Rampell wrote. “In other words, the R&D change was a cynical gimmick intended to make the bill look cheaper for official budget scorekeeping purposes—but that leading Republicans never actually expected, or wanted, to happen.
So, what does that mean for your startup?
Well, let’s do the math. If you made $1m in revenue but spent $2m building software inside the United States, you can’t just subtract $2m from $1m and show the IRS you’re $1m in the red. Instead, you must spread that $2m out over 5 years, which would be $400k per year. Now, the math becomes $1m - $400k, meaning your taxable income looks more like $600k. Even at the lowered corporate income tax rate of 21%, that’s a $126k tax bill for a company that did not make any profit. If your R&D expenses were incurred outside the States, the bill is even higher.
Clearly, this amendment to IRC §174 hurts innovation by American companies—and it hurts innovative startups most of all. So what happened? It turns out the history and politics of it all is… everything.
It is always best to start at the beginning, so let us begin at the very start. The earliest known taxes were levied in Mesopotamia 4,500 years ago.… Just kidding. Let’s jump forward a few millennia.
As far as deductions go, the 1933 Supreme Court ruling in Welch v. Helvering created the framework that only expenses that were both “ordinary” and “necessary” could be deducted—eventually, IRC Section 174 allowed taxpayers to deduct R&D costs (like Section 162 expenses), or capitalize and amortize them over a period of at least 5 years.
It took fifty years before the tax code changed again, this time dramatically, when Ronald Reagan passed the Economic Recovery Tax Act of 1981 (ERTA). The most relevant change for tech companies was the creation of the “Credit For Increasing Research Activities (R&D Tax Credit).” IRC §41 allowed companies a credit for certain US-Based R&D expenditures that met a 4-part test (Permitted Purpose; Elimination of Uncertainty; Process of Experimentation; Technological in Nature) could be claimed as a credit. The law, built to incentivize innovation within the United States, allowed companies to claim expenses like salaries, research expenses, and leased time on the mainframe computers popular at the time as credits. Yup! Congress knew AWS was gonna happen way back in 1981! ;)
The credit was originally intended to be a temporary incentive to boost US-based R&D and was set to expire after a couple of years. But it was so popular that Congress kept reinstating it every couple of years—for almost four decades! It wasn’t until the PATH Act of 2015 that it was finally codified as a permanent fixture in the tax code.
At the same time that Congress was codifying the credit, they decided to tackle another issue that had arisen: the R&D credit could only be claimed as a dollar-for-dollar offset of the federal income tax, which meant it was only being used by profitable companies. Congress understood that, in the Age of Tech Startups, many of the most innovative companies in the country were being left out. So, in 2015, as part of the PATH Act, there was a provision that allowed pre-profit startups to claim the R&D credit against payroll taxes for up to 5 years.
In the years since, the tax credits allocated for innovation within America began to go to more than just the country’s largest companies. More and more startups have begun to understand how to access the money they were owed, which promises to further incentivize innovative companies to create novel and disruptive technology in America. But then, the TCJA with its five-year ticking time bomb came due, and it now threatens to make research and development both expensive and an accounting headache going forward.
The change was written to be implemented five years in the future—that’s another clue that lawmakers expected it to be overturned before it ever took effect. What congressperson would want to pass a law that is guaranteed to be deeply unpopular with small business owners? But no one could have predicted the many unexpected factors that made rewriting an unfavorable R&D tax bylaw infeasible these last few years: a global pandemic, a possible recession, and runaway inflation, to name a few…. So, for now, the law remains, though there is bipartisan support to amend IRC §174 again to make it more favorable to innovative companies in the United States.
This new rule disincentivizes R&D by all U.S. companies, but it especially damages pre-revenue and early-stage startups. Because pre-revenue companies have fewer deductions available, they’ll be forced to utilize more of the Net Operation Losses (NOLs) sooner, which will put them at a disadvantage financially when they do eventually turn a profit. We’ll dive deeper into the ramification of that aspect in a future post.
In the rest of our series on R&D Capitalization, we’ll go deep into the Who, What, and Where of it all. We hope you now understand the Why. It’s frustrating for those of us committed to serving the most innovative companies in America that we’ve found ourselves here, but we’re doing our best to bring clarity and solutions to startup founders.
Winston Churchill is credited with writing: “Those that fail to learn from history are doomed to repeat it.” So, now that we’ve done the history section, we’ll try our own hand at a quotation: “Those who don’t learn about capitalization are doomed to lose the money they’re owed.” And no one wants that…
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The first thing to know about Nic Malianni is that he loves to hustle. Since the age of 12, he’s always had a job: construction, at a golf course, and, most recently, as Head of Accounting at the connected workplace, productivity software company Notion. While in college at California Polytechnic State University in San Luis Obispo, he found himself without a job and felt the itch. So, Nic saw a Craigslist ad from the Donati Family Vineyard and got in touch. “I was 20 years old and you can’t really work at a winery when you’re not 21, but I just said, ‘Hey, I'll do your gardening. I’ll rake your bocce ball court. Whatever you need me to do, I'm happy to get my hands dirty,” he remembers. “So that got me in the door.”
For the next three-and-a-half years, Nic became an indispensable cog at the winery. He took naturally to sales and to systems, getting the young winery’s offerings into local restaurants and grocery stores and managing sales reporting. “Their first vintage was 2003 and I started there when their 2005 was being released,” he says. “So, I consider it my first startup.” He is still a proud wine club member today.
Nic graduated with a Business Admin degree with a focus in Accounting, Finance, and Economics and dove into accounting. Many accountants focus on debits and credits and closing the books, but he’s always started with the needs of the business and viewed the problems with an accounting and systems lens. “It’s always been top of mind to help businesses run more efficiently through scalable systems and processes,” he says. He’s held onto the one feeling that’s proved a motor for his work life: “Curiosity.”
“How do we do this? How can we do it better? How can we make it simpler to help us provide the best service for our customers or to alleviate some sort of pain that my team is feeling?” he says. “In general, finance systems have been pretty underserved for a long time. There's always the hottest new engineering tool or the hottest new marketing or sales tool. Finally, we’re seeing more and more new finance tools like Neo.Tax. I'm really excited about what I'm seeing in the market.”
Nic sharpened his accounting skills at Grant Thornton for four years after college, working on the audit side. “I personally chose Grant Thornton, because I wanted to have as many clients as possible to get a broad set of experiences,” he says. He worked with 50 companies, some private and some public, and got a rare look at their practices, their challenges, and what worked and what did not. He tapped the knowledge of colleagues who had extensive experience in audit but also on the technical side. “It’s a very research-driven profession,” he says. “It gives you a window into the why behind the decisions of how a company makes their accounting decisions.”
But after those four years, when Nic felt he understood the why, he began itching to answer another question: “The missing piece at an auditing firm is the how,” he explains. “Or put another way: the actual execution.”
So, Nic joined Intercom, the AI-empowered customer service solution, in 2016 as the Accounting Manager, eventually moving up to the role of Assistant Controller by the time he left in 2021. “When I joined Intercom, I felt ready to exercise my entrepreneurial/building mindset,” he says. “‘How can I help build this thing and translate that why and to the actual execution behind it?’ That really excited me and it was challenging. Very, very challenging.”
The biggest challenge he faced which he hadn’t been expecting was how essential it was to be a champion for your accounting advice. On the audit side, he’d existed in a place where there were clear rules; it was sometimes confusing why best practices weren’t always followed. But on the other side, he realized that a skilled accountant or controller needed to have the ear of a decision-maker to guarantee that the resources were made available.
“You have to be able to compellingly explain the why in order to get the resources to build the best systems,” he says. “If you don't have resources, then you need to figure out a bandage to account for this in a way that is going to be acceptable until you can build that long-term solution.” Nic realized that was why so many startups struggled with their systems and books early on. “It often falls on the grit of the accounting and finance function to actually go in and just get it done,” he explains.
At Intercom, he used the technical skills he gathered in his years at Grant Thornton and then expanded them by becoming an operator. Eventually, as the company grew, he moved into a management role. “I felt like, ‘Hey, I want to get back to building mode,’” Nic remembers. “That's what attracted me to Notion. And, you know, I've been building ever since.”
Nic wanted to get back to “building mode” but he also wanted to join a company that people loved. “If you look at Notion’s YouTube following, Twitter following, and all the socials, it’s insane how much people love the product,” he says. “The affection for a business software product is just absolutely phenomenal. And it's really rare.”
So, he started talking to people at Notion and realized that their engineers and executives were at the top of their game. “I wanted to be a part of it,” he says. When Nic arrived at Notion in 2021, the company was still just 65-70 employees. He took over as Head of Accounting.
Intercom grew rapidly in Nic’s years there; Notion’s growth has been even more exponential. “I had to grow just as fast as Intercom did and then I joined Notion and the speed has been even faster than that,” he says. “When I first joined, there were a lot of great people and there was a foundation that was put in place. But we’ve had to continue to uplevel the way that we worked, and the way that we serve the business and our customers, and how to do it in a faster manner.”
In his two-plus years so far, his team has added 16 people, Notion’s gone through two acquisitions, and they’ve had to implement numerous systems. With all the steps that I've made in my career, it's kind of been out of curiosity,” Nic says. “If I ever feel like I’ve stagnated from a learning perspective, I know it’s time to change course.” Obviously, the Notion ride has been a learning overload. He’s loved every minute of it.
“It's been a journey,” he says, grinning. “The thing that I've enjoyed the most is that every quarter, there's something new to do and something new to learn.” Obviously, there is ongoing accounting work to be tackled, but “for the most part, it’s not that stereotypical 9-to-5 where you show up and know what you're gonna do every day. That has been very fun from a learning perspective.”
At a startup, the role of accountant becomes a mix of traditional and strategic, which Nic loves. “Especially earlier stage your role is to help the company grow in any way. From a financial side, there are core accounting things like bookkeeping and taxes but there are also strategic tasks like, ‘How can we help design the pricing and packaging to ensure that they’re going to work both from a systems perspective and a customer experience perspective while helping the business grow?’” Nic also mentions that it’s the accountant who looks at every bill and contract, so they should be providing valuable insights to the Go-to-Market teams about how other companies are building their sales engines, pricing their products, and designing their checkout flow.
“The true back-office transactional side is just table stakes,” he says. “But for a startup to succeed, the finance function really has to be strategic. You can live in that land of customer experience and sales strategy, and drive strategic decisions if you want to. I think every accounting and finance person should.”
In September 2022, Adobe announced that it was buying Figma, the extremely popular product design tool, for $20 billion. Since its founding a decade ago, Figma has become an indispensable part of the tech world’s product design toolbag, so the news reverberated across the Valley and beyond. For Figma CFO Praveer Melwani, it wasn’t a ripple compared to a much bigger wake rolling through his life. “It’s funny how timing works out,” he tells us, grinning. “My wife's due date was the same day we were scheduled to announce.”
Praveer is from Toronto and went to school at Western University in Ontario where he studied business administration. His dad was a dental supply salesman and Praveer always envisioned that he’d join the family business, but he had an itch to get out of Canada for a while before coming home. So, he applied for jobs in San Francisco, landing a role at Union Square Advisors in the summer of 2012. “It was just a little bit of luck and good fortune,” he says. Based on where it all went from there, that framing seems like more than a bit of an oversimplification.
Dropbox was scaling rapidly in 2014 and the Strategic Finance team was interviewing hundreds of candidates in an effort to hire the best handful of people to come join. Praveer wowed in his interviews and was offered a spot on the burgeoning team. “Rather than go through the standard venture, hedge fund, or private equity route, when the folks at Dropbox presented this opportunity that sounded like more than finance, I said yes,” he explains. “I had the fluency and understanding of what's going in the P&L so I could help drive some of the business-oriented tasks forward, but, ultimately, I was more excited to learn how this business ticked and moved. That's what drew me in.”
The StratFin team that Ajay Vashee had been tasked to build was designed to attract high-achievers who thought differently about finance. The mandate at the time at Dropbox was “get the very best people in the world to join,” as Ajay explained it, to keep the company on a best-in-class growth trajectory. It proved a perfect fit for Praveer. “I view my capabilities as someone who can come in as a structured thinker and help someone frame a problem in a thoughtful way,” Praveer says. “But I get excited about learning and I get excited about having a much broader footprint than just like the core spreadsheet and operating model.”
Eventually, that desire to expand his footprint led him to leave Dropbox for the Business Operations team at NerdWallet in September 2016. Ten months in, he was laid off. “Within six months, I was already getting to the place where I was itching to do something a little bit different. Soon enough, it was a last-person-in, first-person-out situation,” he says. “But, had I not gotten that kick in the pants to go and look, I don't know if I would have found Figma.”
He credits good luck for much of his success but does admit it’s not the whole story. “Timing, the relationships you have with the people around you, and your ability to react are what make you successful,” he says. “But I think so much of it — the majority of it — is luck.”
When Praveer was hired at Figma in July 2017, it was still a small startup. He was the first business ops hire; his role was amorphous but he quickly was tasked with managing finance and accounting. “My first set of projects was setting up our Stripe instance, making sure that the data was flowing in the right way,” he remembers. “We were using Gusto for payroll and so everything was on autopay. I was just hoping and praying that things were going right.”
Quickly, Praveer began thinking strategically — once a StratFinner, always a StratFinner — and began spending time working in concert with the team launching Figma Pro. “I spent a lot of my energy making sure that the data pipelines were really flowing between our financial systems and what we were seeing on the product side,” he says. That ultimately became my foray to drive conversation around how our users are navigating our funnel and what they’re doing once they're actually on one of our paid plans.”
That first bit of insight gave Praveer entry into high-level leadership conversations. “I found myself being able to provide insights and it actually informed some of the product decisions and the ways in which we structured our sales orgs.” It became clear to the Figma executives that Praveer could deliver strategic advantages if they let him build a finance team.
“Over the next couple of years, we then went from a one-tier company to having a couple of tiers. We went from purely self-serve to having a sales team,” he says. “The team that I was going to architect would tackle building the business infrastructure that would keep pace with the company as we were scaling.”
As he hired, Praveer would give applicants a “silly Excel test” — he figured: “If you understood the ins and outs of the financial statement, you can build a model.” Soon, he built out a team that could tackle any financial task that was thrown their way. “I still would say that today, I'm by no means an expert, but I have tried to hire around myself so that I can feel confident in the collective expertise at Figma,” he says. “I brought on Tyler Herb as our controller who previously was at Slack for a number of years. We brought on an audit committee chair on our board, Kelly Kramer, who was previously a storied and tenured CFO at Cisco. So, I think surrounding myself with the right people was essential.”
Praveer has always been curious to understand all aspects of the businesses he’s worked for and he stressed that same curiosity for his team at Figma. “I pushed my org to always have a pulse on the core sets of drivers and metrics for what is actually the heartbeat of Figma and how can we use that to help drive conversations with the product or to go-to-market teams,” he explains. “I’ve always had that desire and excitement to go and learn about an area that you may not necessarily need to know everything about for your core craft on the finance team. But if you do, that knowledge will make you that much more of an impactful partner, which is part of the core fabric of the culture that we built.”
His finance team was first and foremost focused on driving good financial accountability and hygiene, because “we had aspirations of where we wanted to go,” he says. “We felt that if things keep going, we're going to be in a position where we're going to have wanted to have the rigor a couple of years prior, so that we have a set of financials that folks feel are reliable and thoughtful.”
But that didn’t mean Praveer’s team focused solely on accounting. He’d created a culture where finance could be a motor for innovation and he always encouraged his team to explore every aspect of the company and see where they could lend insight. “And individuals were getting rewarded for it. They were seeing that the conversations that they were getting pulled into were really unique,” he says. “The experiences that they were having at Figma were materially different than they had in other places because they were pushed to do more.”
Early on at Figma, the team offered the service for free. As Praveer sees it, CEO Dylan Field and his team were craftspeople and wanted to keep tinkering until their tool was perfect enough to charge for.
But it was clear to the investors and the business side that Figma had found a pocket of users who knew their product design tool was indispensable. Everyone at Figma finally agreed that charging was the best way to make certain their business — which designers had come to rely on — would be sustainable for the long run. “Customers explained, ‘The only way that we can continue to invest in Figma as a tool for our broader design team is to know that you guys are actually charging for it because that's how we can know this tool isn't going to go away,’” Praveer says. “And so, part of our story is: if you've got something, charge for it, because people will know that you see value in it. They’ll invest in the solution you’re delivering and the system will grow as well.”
Figma took the lesson to heart. They knew their core customers were designers and they wanted to be as transparent as possible with them. They believed there was value in that trust. “We don't discount our product. What you see on the website is what you get. We're really transparent with it and we wanted to use that to our advantage over time,” Praveer says, explaining that their competitors approached pricing very differently than Figma. “We would lean on that transparency and then we’d put our money where our mouth is by delivering outsized value to the customer. That's been one of the core values that we believe continues to be true: we want to make sure that as we invest in the community of designers who ultimately will become our advocates. We want to make it feel like it's a no-brainer decision to pay for the tool.”
Praveer came to Figma when there were fewer than 30 employees as the first biz ops hire. Today, the company has over 1,300 employees and has announced a pending $20 billion sale to Adobe. So, how did Praveer grow in his role as his responsibilities and Figma expanded? “When someone asks me what they should do when they're new in a role, I always say: find that individual that you can ask questions to and not feel any shame. Honestly, no question is a dumb question, especially when you're trying to build something for the first time.”
He leaned heavily on peers from his days at Dropbox who had moved on and helped scale other businesses. There isn’t a situation he can think of when he took on a new task for the first time and didn’t make a call to someone to ask a question or two. It’s that network of expertise that’s allowed him to feel confident as he makes decisions on a larger and larger scale. “Being able to just pick up the phone and learn from folks, whether it’s an idea either for benchmarking or for the type of person to hire, I don't think I could have been able to do it without having folks in my corner,” Praveer says. “So, when given the opportunity to speak and share or have a conversation, I'm always in this like pay-it-forward mentality. I will have a conversation with nearly anyone because I also get a lot of energy from it, but I also think that's what's gotten me to the place that I'm in right now.”
So, yes, he’s been lucky. But clearly, good fortune is just a small part of the equation.
A reminder from Neo.Tax: The tax deadline for S-Corps is coming soon!
For any S-Corp — defined by the IRS as “corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes” — the extension tax deadline is September 15, 2023. So, now is the time to get your books in order and to file your R&D tax credit.
Set up a call with one of our tax experts who can walk you through our automated, streamlined process — because you’re filing in September, you’ll be able to claim the tens of thousands you’re owed by the start of Q4 rather than waiting until 2024.
An important note for California S-Corps: though the state granted extensions for all California companies impacted by last winter’s storms, S-Corps still need to file in September rather than October along with all other companies.
Don’t hesitate to reach out with any questions — we’re here to help!
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