Category: Business Formation

R&D Credit Basics for Startups

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How has the R&D Credit changed?

  • Before 2016, the R&D Credit had to be taken against taxable income – most startups do not have taxable income, so it was nice, but no immediate benefit.
  • For tax year 2016 (returns filed in 2017) and onward, there is an immediate benefit for startups – the IRS will send you check for the Credit – a very immediate benefit!
  • Our clients have received checks from the IRS for over $2M for 2016 R&D Credits.

What is a credit?

  • An R&D Credit gets you “two bites of the apple” for money spent on R&D.

How do you get two bites of the apple? Let’s say you spend $100K on a software engineer. The first bite of the apple is that you get a tax deduction of $100K – this increases your taxable loss – nice, but no immediate benefit until you are profitable and can offset those profits with your accumulated losses.

The second bite is huge, though.  You take that same $100K and throw it into the R&D Credit equation, which typically results in a 7% to 10% credit.

What this means: The IRS sends you a check for $7K to $10K.

What qualifies as R&D Credit?

  • If a product has already been released, costs for small or custom changes on the released product are typically not eligible for R&D credit.
  • If you are working on a new products or releases, those costs are typically eligible for R&D credit.
  • Not all costs spent on R&D are eligible for the R&D Credit:
    • Payroll, Consultants and supply costs are eligible for R&D Credit.
    • Payroll benefits, travel, office rent, computers, design software costs are examples of costs that are not eligible for the R&D Credit.

BEWARE!

  • The R&D Credit is an IRS Tier 1 issue – that means if you get audited, you better have a ton of documentation and justification for the Credit.
    • Documentation: it is best to have a timekeeping system (online, very simple is fine) to justify time worked on the different R&D projects by employees and contractors. If there is no timekeeping system, you can document the time worked with “interviews” – this should really be done by an outside firm (they charge between 10% to 15% of the total credit).
    • Justification: There is a very well publicized IRS Four Part Test for eligible R&D projects.  Lab books, project plans, gant charts, meeting notes, drawings, etc. should be kept proving these projects are eligible.

 

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IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purposes of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Hiring Interns this Summer? Useful Tips for Startup Companies — From the ‘Go To’ Tax and Accounting CPAs

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Hiring unpaid interns is a great idea, but it can be a legal minefield: There are more than a few obvious reasons why a startup might want to hire an unpaid intern but it can be a confusing web of laws and requirements. The Department of Labor and State Governments can impose hefty legal consequences for not properly classifying interns. How do you know if you can hire an unpaid intern? There are six-factors laid out by Department of Labor to determine whether it is legal for you to hire an unpaid intern. You can find the test here.

Hiring foreign students: Since there are certain laws regarding hiring students with J-1 and H-1 visas. For instance, many universities and colleges will limit the period in which students with Visas can work and the Department of Labor regulates the amount of time per week they can work. Some states have specific requirements that non-profit and for-profit companies must abide by. For instance, New York requires that any student intern that will perform any amount of manual labor (cleaning, filing papers, carrying binders or books, etc.) must be covered under the employer’s workers’ compensation. It is important to understand all Federal, State and Local laws before onboarding interns.

When in doubt, pay them out: The Department of Labor has complex laws that apply to foreign and domestic interns. Because each startup has its own unique needs, you cannot always legally hire an unpaid intern. If you have any reasonable doubt that a potential unpaid intern will not meet all of the six factors laid out in the Department of Labor test, it is always best to hire them as an employee and pay them according to Federal, State and Local laws.

You Incorporated Yesterday, Ten Things You Need To Do Today…

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Well, maybe not today, but certainly within the next month.

 

  • Register your business with your State’s DOR.  Most states require you to file and pay taxes and unemployment insurance online.

 

  • Understand your Secretary of State filing requirements.  And you may have more than one Secretary of State filing if you incorporated in one state, such as Delaware, and are physically located in another state.

 

  • If you are selling stuff, understand that you may need to charge sales tax.  Forty-five states, DC and Guam have sales tax and each have very different, unique rules.   Also, some states may have the “Amazon” tax, whereby online retailers need to charge sales tax even though they have no physical presence in the state.

 

  • Know which workers are independent contractors and which workers are employees.  The IRS slap you really hard when you get caught “pushing the envelope” with independent contractors.  If you have employees, you need Workers’ Comp insurance.  NEVER PAY ANY WORKER UNDER THE TABLE.

 

  • If you have employees, engage a payroll service, such as Zen payroll and use their tax service to file and pay your payroll taxes.

 

  • Open a business bank account and pay all of your bills from this account and make all of your deposits into this account.  If you are running a payroll, open an additional checking account and ensure “Payroll Account” is somewhere in the name of the account (it is an IRS thing).

 

  • Get a monthly subscription to QuickBooks Online or use a bookkeeping service such as Bench Accounting.

 

  • If you want a business credit card, read the fine print – you are signing personally, even though the business’ name is on the card.  It is a real horror story when you leave the business, do not cancel the cards and the business does not pay the bill.  The credit card company, especially AMEX, will aggressively come after you.

 

  • Set up a Stock Plan to legally and tax-efficiently compensate workers, consultants and directors with stock options or restricted stock grants.  The plan should hold about 15%-20% of the outstanding equity of the business on a fully-diluted basis.  Engage a lawyer who is familiar with these plans, as there can be several legal and tax pitfalls and these plans have many moving parts.

 

Now smile.  It does not get better than this.  Even if grow this business into a mega-corporation, there is no more fun than starting a business and setting it up properly.  Good luck.

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IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

 

 

 

 

Stop! Think Before You Incorporate

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We work with a lot of college student entrepreneurs, young entrepreneurs and first-time entrepreneurs.  We are often asked “..should we incorporate or form a Limited Liability Company (“LLC”)?”  Sometimes, these entrepreneurs have visited a lawyer first, and have already incorporated or formed an LLC.

Based on our experience of often, “picking up the pieces”, we have developed three rules for these entrepreneurs.  (Note that these do not apply to sponsor-backed (VC/PE/Angel) companies, but strictly to “bootstrapped” businesses that are funding operations with personal funds).

  • Before you make the decision to incorporate or form an LLC, visit an accountant who is familiar with closely-held businesses and discuss, quantify and  thoroughly understand the following and ensure these additional and often substantial costs justify the corporate benefits:
    • Income Taxes differences of a C Corporation, S Corporation, LLC, Proprietorship
    • Secretary of State initial registration fees,
    • Secretary of State annual fees/taxes
    • Resident Agent fees
    • Minimum annual State Income Tax
    • Income Tax compliance fees

 

  • If you decide to incorporate or form an LLC, do not get talked into incorporating or forming in Delaware or Nevada – do it in the state where you are physically located.  Delaware and Nevada are fine choices for sponsored-backed companies or companies about to go public, as the do have certain advantages, such as the Delaware business law flexibility and the Nevada indemnification benefits.  For bootstrapped companies, though, these advantages are not worth the additional registration fees, annual fees and compliance costs – you will get a better return from these funds by investing them in your business.  If you raise VC/PE/Angel funds, you can always choose to change your state of incorporation very inexpensively and with someone else’s funds.

 

  • Do NOT incorporate too soon. Even though your lawyer may be pushing the personal liability protection of corporations and LLCs – there is a good chance that no one will sue you, especially if you do not have substantial assets (such as college students).  If you do get sued for Negligence or Fraud, the corporate veil will not protect your personal assets.  If you decide not to incorporate, ensure that you register the business with your city or town (file a DBA) and have the proper Property and Casualty insurance.  Also, if you have other partners, ensure that you develop and sign a comprehensive agreement that details issues, such as ownership of IP, ownership percentage of business, funding issues, tax allocations, withdrawal of a partner from the business, and all other potential issues involving the business.  It is best to agree to this early in the life cycle of the business and then draft the agreement and, then, present to a lawyer to edit, finalize and memorialize.

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IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

 

 

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