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The Startup's Guide To Payroll

By Neo.Tax Team

So you’re a startup and believe the best way to get the help you need to build your company is with independent contractors... hmmm, interesting. 

It’s your company, so we’re not here to tell you how to run it, just that you’re missing out on up to $250,000 in research and development tax credits by not setting up payroll. 

Yup, you heard that right. You could miss out on hundreds of thousands of dollars because you either haven’t set up payroll or you've set it up incorrectly. 

Imagine what you could do with that money. Maybe: 

  • Extend your runway
  • Help continue necessary R&D
  • Reduce burn

Have no fear, Neo. Tax is here!

Check out our guide to setting up your payroll taxes as a startup or new business. 

Why not Independent Contractors? 

Let’s be clear: you can report independent contractors on your R&D tax credit claim. 

The credit is a percentage of your QREs, also known as qualified research expenditures. These expenditures include in-house research expenses and contracted research expenses. Contract research expenses are handled a bit differently than in-house research. Only 65% of contractor research can be claimed–here’s an example of what that means:

Say I want to research sneaker materials as I’m developing an innovative new style of lifestyle shoe with posture support. I need to get some research from an outside firm; the cost is $100k. When reporting this expense for your R&D credit, only 65% of that independent contractor’s payment will count toward your credit claim. Essentially, $65k of this firm’s bill. 

Now, let’s say you realize your needs exceed just research on materials and you contract the same firm to conduct an analysis of the sneaker market and who the target audience for the shoes will be at the same time. The cost is $250k; $100k for research on materials and $150k for the marketing analysis. Typically, marketing expenses are not qualified expenses for the R&D tax credit. This means you can only claim 65% of what you paid to the firm for R&D only–which, in this case, amounts to $100k of the $250k final bill. 

The same calculation applies to percentages of time as well. Let’s say the firm bills hourly and states they dedicated 200 hours to R&D at $500/hour, which is one part of the final $250k bill from the firm. It’s then up to you to calculate 65% of those 200 hours that go toward your claim. Again, in this case, you could claim $65k of the firm's bill toward your R&D tax credit. 

Remember: as a company that is not yet profitable, your R&D credit comes as a payroll deduction. This means that even if you’re employing independent contractors, you must set up payroll in order to receive your credit. 

Where To Start? 

If you’re already working with an accountant or accounting firm, then they can handle all your payroll needs. 

If not, think about getting a payroll provider like Gusto, or learning the ins and outs of payroll yourself. 

After you’ve set it all up, find trustworthy R&D tax credit software to help you seamlessly integrate your payroll and accounting information to claim your R&D credit. 

Want to learn more about R&D software? Check out our post about what to look for. 

More often than not, setting up payroll boils down to these steps: 

  1. Gather necessary documents like your company’s EIN, state or local Business ID, and your employee’s onboarding information, as well as their employee classification–if they’re part-time or full-time, etc.;
  2. Choose your payment schedule or pay period; 
  3. And decide on a payroll system or provider. 

Resources & Tips 

Now that you’re setting up payroll, it’s a good time to pay extra attention to the details of all your records. The IRS can be fickle, so it’s always better to stay ahead of your payroll filings. Here are some resources to help you along your payroll journey. 

Forms: 

  • Form SS-8: If you’re wondering how to classify employees and/or determine worker status for Federal Employment Taxes and Income Tax Withholding, this is the form.
  • Form I-9: Your go-to form for employment eligibility verification.
  • Form W-4: You’re probably familiar with this one. It’s your employee’s withholding certificate. 
  • Form W-2: Another familiar one is this–the wage and tax statement.
  • Form W-9: If you’re working with independent contractors, then you definitely know this one. This is your request for taxpayer identification number and certification.
  • Form 941: this form is the employer’s quarterly federal tax return.
  • Form 940: and last, but certainly not least, the employer’s annual Federal Unemployment (FUTA) Tax Return.

Payroll can be one of the more complicated processes, making it extremely important to have a solid Payroll Dream Team that will help ensure your company payroll is done accurately and on time! If the ‘92 Men’s Olympic Basketball Team taught us anything, it’s that the Dream Team exists. 

This is who you should have on your Payroll Dream Team:

  • A trusted accountant or accounting firm, 
  • Accurate accounting software, 
  • Payroll software that integrates seamlessly with your accounting software, 
  • And, if you can swing it, a human resources manager, COO, or business partner. 

Here are a few more tips for payroll: 

  • Make sure you pay close attention to your records and fill every form out correctly. 
  • Always, always, always file your payroll taxes on time. This not only ensures that you pay employees on time every time, but also helps avoid overpayments or any other mistakes. Here are some deadlines to mark in your calendar. 
  • Don’t forget to keep your records organized and remember to keep former employees' records for 3 years after separation from the company. 

Payroll is a fundamental part of claiming your R&D tax credit as a startup or new business. Set it up and watch the R&D credits flow in. 

Trust us, it’s worth it!

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