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Reduce your startup's payroll taxes through the new Federal R&D Tax Credit (gusto.com)
205 points by edawerd on June 27, 2017 | hide | past | favorite | 77 comments



As an accountant I have had to shoot attempts at claiming this credit down time and time again. Unless you are doing cutting edge/novel research into AI, machine learning, quantum computing, etc you will not qualify for the credit. Think about it this way, unless your research is something you could write a scientific paper on and have it published in a peer reviewed journal, it will not qualify.

Also, this is not a new R&D tax credit, it was extended, again, for the umpteenth time. There were slight changes made in addition to the extension, but they did not change what qualifies as qualified research.

Gusto is trying to drum up business, that is all.


Think about it this way, unless your research is something you could write a scientific paper on and have it published in a peer reviewed journal, it will not qualify.

That's not true at all. In the US, at least. As a tax lawyer, I've had to have this conversation quite a few times with accountants who misread the law and don't think it applies to their clients.

The US R&D credit has 4 basic requirements, and "cutting edge" is not one of them, nor has it ever been.. Generally (broadly paraphrased), it is sufficient that the R&D result in new (or improved) functionality, etc. of a business component (specific to the taxpayer), in a systemic process of a scientific, engineering, or computer-science nature.

For example, a game developer developing a new game engine would qualify for the R&D credit; as would a retail company developing an improved inventory system. (The latter is in fact one of the examples that IRS employees give at tax seminars.)

The real issue with the R&D credit isn't claiming the credit; it's supporting the amount claimed with proper and sufficient documentation. It's the documentation part that gets most taxpayers, since the R&D credit is one of the areas that the IRS still devotes resources to auditing.

Further edit: by the way, Gusto's article is about the new small business R&D credit from the Protecting Americans from Tax Hikes Act (PATH) which went into effect for the 2016 tax year. The original credit is limited to taxable income, so you couldn't use it until you had profits or if you were subject to AMT. The new credit applies against federal payroll and AMT.


Let's say I pay a programmer to develop that new game engine...why wouldn't I just deduct the expense of paying the developer against my revenue? Why would I even need to look into this tax credit? The only companies I see this benefitting are those with no or negative income, but have high payroll taxes, which doesn't seem to me to be a lot of companies out there.


Deduction applies to pre-tax income, and is based on your tax rate. If, for example, you have a deduction for $100, and your effective tax rate is 20%, your tax liability is reduced by $20. Deductions also generally don't carry over if unusuable.

A credit applies against your tax liability. So if you have a tax credit for $100, your tax liability is reduced by $100. Credits generally do carry over to future years to the extent unusable in the current year.

Whether a credit is preferable to a deduction depends on the taxpayer's tax situation, including whether they would be able to make use of carried-over credits in future years.

Edit: in a previous comment I said R&D credits aren't available if you don't have positive income. That's not strictly true. R&D credits only apply against actual tax liabilities, but if you don't have any taxable income the unused credits would carry over into a future year for potential use.


This credit is unique in that it can be used against federal payroll taxes. i.e. most companies (even if unprofitable) can realize a cash benefit immediately


Thanks!


I would bet practically all software startups fall into the category of having negative income and high payroll taxes.


In addition to the other posts, if your developer is creating a capital asset (software/IP with a useful life beyond the current tax year), you may not be able to expense 100% of their cost.

It's just like if you hire a builder to make you a rental property. You can't deduct 100% of the costs of that house in the year it's built.


At my work, we specifically log hours differently if we're working on new development versus bug fixing to document our work for the R&D credit.


Are you sure that's why? Many companies do this to differentiate between capex and opex, but it's rare that all new development would qualify for R&D credit.


Yeah, we had an all hands meeting where they explained that this was the reason. We're small, and money is tight, so saving a couple hundred thousand dollars a year is a lot of motivation for people to track their time accurately.

We're basically creating a new industry niche, so it is clear R&D. It's not like we're just churning out new shopping carts sites for the customer of the week.

We're just wrapping up our Series A, which included a major investment from CAT though, so we're in a lot better shape than we were a year ago when we started the initiative to take advantage of the tax credit.


I agree with all but your first sentence... I think you are just underestimating what topics can have peer reviewed scientific papers written about them.

http://ac.els-cdn.com/S235197891500013X/1-s2.0-S235197891500...

I was more taking a shot at the companies who do a redesign/facelift of their website/customer portal, or a bank struggling to integrate an off the shelf trading tool into their systems.


If you're agreeing with gamblor, you're doing it in a way that sounds completely different and much narrower than what they're suggesting. My take from your parent comment was "don't bother", and my take from gamblor was "this is very doable". Pretty big difference.


I'm not sure what you're getting at. The first is a clear example of a permissible R&D credit activity if it otherwise satisfies the 4 requirements, and courts have found that the second activity generally would also be permissible for R&D credits if the integration involved additional software development by the bank (though this is more of a facts-based determination).


Also, it's not necessarily a tech requirement. A restaurant developing a new menu as it tests out recipes is just as much R&D as anything else.

No idea why people think R&D needs to be cutting edge tech research...


I'm not sure why you're being downvoted. The development of menu items can be a permissible R&D credit activity.

At the level of a national or regional restaurant chain, it would definitely qualify. The development of menu items for a large chain involves a significant amount of research and scientific experimentation to nail down ingredients, storage and cooking processes, etc., that meet certain financial metrics, nutritional requirements, regulatory requirements, etc.

For a one-location restaurant, or small chain, it would be a lot more difficult to qualify for R&D credits. You'd have to show that menu items were developed to meet specific predefined targets in ways that would not have been obvious without the research/experimentation activity. Flavor is an acceptable target if the flavor can be clearly defined.


No... one of the requirements is "research which is undertaken for the purpose of discovering information which is technological in nature"


The R&D credit is not limited to research undertaken for technological discoveries. I'm still not sure where you're getting that idea from.


Might a restaurant specializing in molecular gastronomy[0] devising new dishes qualify then?

[0] https://en.wikipedia.org/wiki/Molecular_gastronomy


Generally yes. The tricky part is documenting how they qualify for the R&D credit.


Basically all food production is "technological in nature".


As far as I can tell this accountant is spreading misinformation. (I've never written that before!)

I've talked to other companies doing nothing related to novel research, just standard SaaS, who were able to get a healthy sized deduction.

Please don't let this person dissuade you from checking if you can get the credit.

To the accountant - please see all the comments below yours and edit your post, unless you have evidence against them. Your comment may well make people not apply for this who could've gotten the deduction without issue.


As a tax lawyer who works exclusively on section 41, you're completely wrong. You should send your clients to tax consultants who know what they're talking about because you clearly do not. Section 41 is a taxpayer centric test, so the work does not have to be "cutting edge." It merely has to resolve technical uncertainties via a process of experimentation.


I have no idea why this is the top most upvoted comment. I know of many companies doing nothing near the level of cutting edge R&D work that the poster claims is necessary, but have gotten substantial tax breaks from this application.

cde-v is spreading categorically false information to the potential detriment of many entrepreneurs. This comment should be downvoted or flagged.


> I have no idea why this is the top most upvoted comment

HN thinks if you can shoot something down it means you're smarter than that thing. Therefore the most negative sentiment is the most intelligent, and should be voted to the top.


While the R&D tax credit is not new, one of the tweaks was not a slight change.

Before, you could only offset your corporate income taxes, so you couldn't claim the credit if you weren't profitable (because you wouldn't have corporate income taxes). Now, you can offset social security taxes, which are based on payroll. So more startups can now benefit from this credit.


I don't have time to look at the details of this particular incentive, but I know from personal experience that many R&D tax credits do not require earth-shaking research to qualify.

I own two SaaS companies that have received R&D credits and I'm also an investor in a few other businesses, including an injection molding company, that have received R&D tax credits. The injection molding company mostly makes cups for gas stations. Which is not exactly quantum computing.

I used the same company to get all of the credits. They had a staff of tax attorneys, accountants, engineers, etc. that worked with us to see what we could qualify to receive. They looked at about 30 different programs to get tax incentives or reduce expenses. And they worked entirely on a contingency basis, where we only paid them a percentage of what we saved. They were very accurate in their initial assessments, and we have not been audited since receiving the incentives (/knock on wood/)

At one point, they commented that the bane of their existence (as tax incentive specialists) was misinformed accountants that thought you had to have an army of lab coats or a clean room in order to qualify.

I would agree, however, that Gusto is trying to drum up business.


You don't have to pass the requirements, you just have to pass the person who reviews your proposal. Put enough fancy language in there and you can make it sound like a simple messaging app is cutting edge machine learning. Every company I've worked for has done similar with the Canadian program (SR&ED).


> Put enough fancy language in there and you can make it sound like a simple messaging app is cutting edge machine learning.

Good luck if you get audited, though.


We got audited. They just reduced the payout. It's the appeals process that's a pain in the ass. Takes about 3 years.


> Unless you are doing cutting edge/novel research into AI, machine learning, quantum computing, etc you will not qualify for the credit

that's patently untrue, I know plenty of firms claiming this credit, not doing cutting edge research, and who are not getting audited.

My personal guess on audit risk rule of thumb is how close to zero does the R&D tax credit get your tax liabilities. e.g. If after the credit, you still pay a lot of taxes, your audit risk is low.


I know more than two software companies first hand that are not doing "AI, machine learning, etc" who qualified for this in the past.


Yeah, oddly enough I believe this accountant is 100% incorrect.


I'm not an accountant, but work in an incubator where a well-known accounting firm came in and presented on this to a bunch of software startups. Their recommendation was to take advantage of this, even if you're not doing anything super novel/cutting edge.


We're only enabling those startups that already qualify for the R&D tax credit to much more easily, and cheaply, claim it. We've seen accountants charge customers up to 25% of the credit obtained, and we think we can help.


This post reminds me of about 70% of accountants. "Unless the tax code explicitly says you can do, it I'm not going to let you!" Then there's accountant that say "It's sort of a grey area, I suppose that makes sense, are you willing to defend it at audit?"

The whole system is designed to discourage risk; and so many people say "I won't write off what I'm entitled to because I fear an audit."

Then I hear stores about accountants that say "Well you're not flagged unless you're over X% of revenue on expenses in this category, so go ahead and increase it."

Like so many well defined laws, there's a lot of room for intepretation.

IANACPA


Must the work be performed in the US to qualify as an R&D tax credit? Thank you


Yes. Limited to US-based activities. The primary purpose of the R&D tax credit is to incentivize the performance of R&D activities in the US instead of off-shoring it to cheaper jurisdictions.


That makes sense.

So it really doesn't make much sense to outsource offshore during the seed stage of a start up.

Can R&D credits be applied to future year earnings?

Is there a time limit for retroactively claiming these?

Thank you!


This is categorically wrong. HN sure loves a contrarian comment, even if it's completely incorrect


But if your startup is developing conversational AI? Wouldn't that qualify? Do you actually have to be publishing? Where's the dividing line in your opinion?


It's working! I didn't know about this credit and I'm fairly sure we qualify. I think many companies building internet infrastructure can.


Hi there. Another PM chiming in from Gusto on Federal R&D :).

While you may be eligible, you will need to make sure that you have filed Form 6765 with your 2016 Corporate Tax Return. The good news (I guess) is that if you didn't file this form you can amend you Corporate Tax Return (https://www.irs.gov/pub/irs-pdf/i6765.pdf). However, just be advised that the process to amend a corporate tax return is often pretty painful. So you may want to be sure that the credit will be worth your while.

It sounds like you are eligible, but I would double check with an accounting firm just to be sure. If you go to our accountant page (https://gusto.com/partners/find-an-accountant) look for "Offers R&D Tax Services" on their company listing. This should give you some very reputable firms to work with on your credit study.

Good luck with your Credit!

Michael from Gusto https://www.linkedin.com/in/michaelnierstedt/


Can you clarify sources for what types of R&D activities apply? I've been curious myself and didn't see this mentioned in the blog post.


If your company is looking to see if R&D credits are available, consult with an established major accounting firm or R&D-specialist firm. (But not cde-v's firm.) Most firms that do R&D work will charge a percentage of the R&D credit recovered rather than an out-of-pocket fee, so you generally won't have any financial outlay if your business doesn't qualify.

Generally speaking, any US-based systemic research- or experimentation-based process that results in the development of new or improved (cheaper, better, etc.) business components (broadly meaning goods, services, processes) can qualify for the R&D credit.


Sounds like even sales funnel optimization with A/B testing would qualify.


Honestly, as evidenced by the rabid response above, reading the actual regulations is the best way to understand this topic.

https://www.irs.gov/pub/irs-regs/research_credit_basic_sec41...


Why do you shoot down attempts instead of letting them try? Is there any downside of trying and get rejected? Judging by the comments it sounds like you risk shooting down attempts that may actually succeed.


While I do think the grandparent is being a little too conservative, there is no "trying and getting rejected" here. This is not a credit that you apply for, it's part of your income tax filing. The only case where it would be reviewed is if you were audited by the IRS, and if they then disallowed your credit, you would be liable to repay that amount, plus interest and potentially plus late-payment penalties. AND, you would likely be flagged as a target for future audits ...

In general, when you claim a deduction on your US income taxes (personal or business) you want to be pretty darned sure that the deduction is going to stand up to an audit.


Replying to my own comment since I'm too late to edit. Just read the regs people, the barriers are not as low as the little bit of anecdotal evidence in this thread are suggesting.

https://www.irs.gov/pub/irs-regs/research_credit_basic_sec41...


1) Those aren't regulations, those are statutes. It is disturbing that you are attempting to advise people on this subject but do not know the difference. Statutes are written by Congress, regulations are written by the Treasury Department to implement or clarify statutes.

2) The PDF is for the 2004 version of the R&D statutes. They have been revised significantly since then.

3) Current version of the statutes: https://www.law.cornell.edu/uscode/text/26/41

Current version of the regulations: https://www.law.cornell.edu/cfr/text/26/1.41-1

Cornell is not an authoritative source but it's easier to read than the GPO website. If you want final authoritative sources, you'll need to read the House and Senate resolutions and to track down a physical copy of the appropriate issue of the Federal Register.


It really is a shame that this accountant person is tripling down on everything without actually having the needed domain knowledge.

Thanks for following up on each of these -- as a small business owner that might pursue this, it's often difficult to separate signal from noise without having much time to spend on it.


I think most people here are basically saying "its a grey area and it would be stupid not to take advantage of the credits even if you feel you don't 100% qualify".


Patio11 says that US-based software employers should also look into the Domestic Production Activities Deduction:

https://twitter.com/patio11/status/879238827612684288


Interesting and could be helpful, but I'd like more details about the "new Federal R&D Tax Credit" specifically

Is it this (which does not appear to be new) or something else?

https://en.wikipedia.org/wiki/Research_%26_Experimentation_T...


2 things are new:

- Before, you could only offset your corporate income taxes, so you couldn't claim the credit if you weren't profitable (because you wouldn't have corporate income taxes). Now, you can offset social security taxes, which are based on payroll. So more startups can now benefit from this credit.

- Gusto has rolled out an new tool that allows their customers to much more easily claim their R&D tax credit, taking on much of the grunt work.

Disclaimer (?): I'm a PM on Gusto's payroll team


There's something gross about being able to avoid social security contributions as a government provided business incentive. I get it wasn't a Gusto decision (and that they're just enabling claiming the benefit), but it's still unsettling.


There's nothing wrong with it if the funds still get to the trust fund as a transfer from general revenue funds.

Now, I don't think that's actually what the policy change has done, but the problem isn't allowing firms to offset the tax.


Actually, it is the right kind of incentive. If you are doing innovative work - go hire more people, because your payroll will be lighter.


At the expense of shortchanging an already underfunded social program.

The right kind of incentive would be a grant, just like the earned income tax credit which comes out of the general fund.

It wasn't enough to get rid of pensions, stagnate wages, shift most income to the top 1%. Now we're going to fund innovation out of the piggy bank of the social program that keeps most elderly out of poverty.

That's my point. It's the wrong way to build a business incentive.

No offense intended to Gusto.


Credits like these don't necessarily affect the actual money flowing into social security—social security is just used as a "taxation basis" in this case. That being said, that is a hypothesis—I'd have to look at the precise funding plan.


What sort of expensense qualify as R&D? If I have a small SaaS business (operating as an LLC), does it even make sense to pursue this? I'm always looking for ways to reduce my tax liability as revenue is about 6x of expenses.


In the U.K. you can trade in your R&D tax credit for cash.

Protip: Instead of living off savings it may be beneficial to lend money to your startup in order to pay you so the wage can count towards an R&D credit. But make sure to see an accountant to make sure the numbers work in your particular case.


What if I have R&D expenses in a side business- can I use the credit to offset my main job's income tax?


No, the credit claimed for the side business can only offset income from the side business, and only if your side business is incorporated (but S corporations count).


I am not an accountant.

You may use a loss from a side business in order to offset W-2 income. No need for complicated tax credit forms. Look into the IRS rules around hobbies as they may get suspicious if your "business" loses money for years on end.


This is accurate (I take losses on an LLC occasionally against W2 income).

Regarding business vs hobby criteria: https://www.irs.gov/uac/business-or-hobby-answer-has-implica...


Not an accountant, but the article states is applies against the business's social security taxes:

> Beginning in 2017, qualified small businesses may claim up to $250,000 per fiscal year, applying it against their Social Security taxes.


No, unfortunately you can't.


[flagged]


That's because Trump had nothing to do with enacting this. It was passed in 2015.

https://www.mossadams.com/articles/2016/february/r-d-credit-...


Yeah this was passed with bi-partisan support. The idea was to help small businesses be able to take advantage of the R&D Credit that has existed since 1981. Since the amount could only before be claimed against Corporate Income Tax you couldn't utilize the credit unless you had profits to offset. Since most small businesses run at a loss or zero profit this was a solution to allow them to get the benefit.


The layers of control in the current economy seems boundless. Makes me want to join the goldbugs sometimes. Hard money seems so much simpler and freer. An anonymous, portable, fungible, hard to counterfeit and inflate, universal account of previous work value. People give it to you when you give them something or a service they want. It seems like a system of the people, by the people, and for the people.


If these characteristics of money are appealing to you check out Bitcoin. Its digital, distributed, decentralized, and impossible to counterfeit which as a programmer and engineer I find incredibly fascinating.


I can't tell if you're being sarcastic or if you genuinely think someone on HN hasn't heard of Bitcoin.


And after a while, maybe we could pool resources together for projects such as infrastructure, bridges, fire stations, that are too expensive for any single person, but from whom we would all benefit! It would be great! We could all give some of our money for these! Let's call this way of doing things government. Oh wait.


Was not criticizing the government in particular, just commenting on one aspect of how monolithic systems over time become inscrutable to the humans that have to use them. See Kafka who lived under the Austro-Hungarian Empire for some famous literary examples.


Governments have operated without fiat currency for a long, long, long, long time.




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