Overview

The Federal R&D tax credit is a government incentive that rewards startups for innovation in the United States.

For money spent on developing new products or technologies in the U.S., your startup can receive up to $500,000 per year for five years. This is especially valuable for unprofitable startups.

This credit can only be claimed when filing your annual tax return. Have your tax preparer conduct an R&D study and include it with your tax filing.

How it works

1

Claim the credit

This must be done when filing federal income taxes. Once claimed, the credit is there to be used for the next 20 years.

2

Use the credit

Once claimed, the credit can be used in two ways:

Option 1: Reduce income taxes

For profitable companies, the R&D tax credit directly reduces taxes owed at time of filing.

Option 2: Get payroll tax refunds

Most startups receive their R&D tax credits this way. However, this approach is only allowed if your company is ≤5 years old with ≤$5M of revenue in the filing tax year.

After claiming the credit, as you run payroll and pay payroll taxes, your payroll provider will submit a claim to the IRS quarterly.

About 10-12 weeks after each quarter, the IRS will mail a refund check for payroll taxes paid. Refunds will continue until all R&D tax credits are utilized.

Refunds take longer with PEO payroll providers because the IRS processes all companies under the PEO’s name.

R&D activities

R&D activities are US-based expenses incurred while creating something new or improving an existing product.

For startups, this generally includes

  • US-based wages for full-time or contractors for founders, engineers, product managers, or designers defining, designing, or coding new software and ideas
  • Raw materials for prototypes
  • Hosting and server costs

And it generally excludes

  • Wages for the portion of time spent on bug fixes, support, website, brand, marketing, user interviews, hiring, fundraising, operations, etc.

Eligibility

Any company with qualified R&D activities in the US can claim the R&D tax credit.

Credit amount

You can typically get:

  • US-based employee salaries: 10%
  • US-based contractor payments: 6.5%
  • Hosting fees: 10%
  • Raw materials: 10%

Credits offset income taxes or get refunded for up to $500,000 in payroll taxes annually.