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R&D tax credits most startups should consider
Section 41 of the Internal Revenue Code lets qualified businesses claim multiple federal tax credits for expenses related to the research and development (R&D) of a “business component.” That can include products, processes, techniques, software, and more.
The calculations behind the credit amounts are complex, but the two primary potential benefits for startups include:
- Dollar-for-dollar income tax reduction: Qualified businesses can typically claim between 6% and 10% of eligible R&D costs each year as a nonrefundable tax credit that reduces their federal income taxes dollar for dollar.
- $1.25 million payroll tax reduction: Startups with no more than five years of gross receipts and less than $5M in gross receipts for the credit year may be able to claim up to $250K in annual FICA payroll tax credits for up to five years.
Since the passage of the Protecting Americans from Tax Hikes (PATH) Act of 2015, these R&D tax credits have become much more accessible for the average startup founder or small business owner.
If you incur any labor or material costs related to R&D, you should strongly consider consulting an expert startup tax accountant to determine if you can claim these lucrative tax credits.
Other strategic financial considerations for startups
Startups face a variety of other strategic financial challenges that startup accounting services can make much easier to navigate. For example, some of the most important issues for you to consider include the following:
- New business formation: Your choice of legal entity–such as a C Corporation, S Corporation, or limited liability company– can significantly impact not only your annual taxes but also your ability to raise funds from an investor or achieve a favorable M&A exit.
- GAAP compliance: Adopting Generally Accepted Accounting Principles (GAAP) and accrual accounting can be an intimidating undertaking, and lenders and investors often require GAAP financial statements before they’ll consider working with you.
- Sales tax compliance: Many startups have sales tax responsibilities in multiple states. Determining where you have nexus, collecting the proper tax amounts, and filing returns across all of them can be incredibly challenging.
- Long-term financial planning: As your startup grows in size and complexity, it becomes increasingly difficult to make informed business decisions without analysis techniques like cash flow forecasting or financial modeling.
Waiting too long to tackle these types of financial challenges only ever makes them harder to manage. As a result, it’s often wise to engage a startup accounting service sooner rather than later to prevent them from escalating, rather than waiting and trying to fix mistakes later.
What to look for in a startup accountant
If you’re a startup founder searching for an outsourced accounting service, competitive rates should be considered table stakes. Beyond pricing, here are some of the most important things to look for before choosing an accounting firm to manage your financial records:
- Relevant experience: The specific challenges involved in accounting for startups can vary significantly between industries. Make sure you choose an accountant who has a proven track record of successfully guiding businesses through the complications you need help navigating.
- Technological compatibility: You may be surprised that conflicting tech preferences can be a significant hurdle to clear when collaborating with financial service providers. Look for an accountant who is willing and able to use the software you use or plan to implement.
- Strong reputation: Look for accountants who have received positive feedback from their previous customers. Referrals from your network are a great place to start. Crowdsourced online reviews can also help, but keep in mind that people are more likely to leave them when upset, which can skew results.
In addition, pay attention to less tangible characteristics, such as communication style and cultural fit. Many Certified Public Accountant services offer free consultations, which can be an excellent opportunity to gauge how well you’re likely to collaborate with them.
