May 17, 2020 How To Choose a Firm For Your Software Startup R&D Credit Study
What is an R&D Credit Study? Look at it as a form of “insurance” if the IRS audits your tax return.
Will not bore you with tax law, but the R&D Credit can now be monetized by startups – you can “cash it in” and get a refund of your payroll taxes.
The amount of the R&D Credit for most startups will be 10% of the sum of their “qualified R&D expenses” (QRE). “Qualified” means R&D projects for new product development or major releases. For most startups, “Expenses” mean payroll, US contractors and tangible supplies.
If you get audited, the IRS will do two things.
- Audit your projects to ensure they pass the IRS “Four Part Test” – most startups will not have a problem here as they are working on new products or major releases.
- Audit the time that your R&D staff/contractors work on these projects.
So, the issue will be proving the amount of time that your staff/contractors worked on each project. The IRS gold standard is contemporaneous timekeeping data, i.e. a timekeeping system. No startup that we know of has or ever plans to have a timekeeping system.
So, how do you prove time to the IRS Agent (keep in mind that it is a felony to lie to an IRS Agent)? Hence, an R&D Credit Study!
But, not all R&D Credit Studies are created equal and the IRS knows this. Here is our take on the Studies being offered:
- Studies that just ask you to estimate the percentage of time that your staff/contractors were involved in R&D and multiply that percentage by their compensation to get the QRE.
- Useless, as this provides no substantiation – IRS Agents love these as they will probably disallow the whole credit and make you pay them back with penalty and interest.
- Studies that will conduct in-depth interviews with each of your staff/contactors to substantiate their time worked on each R&D project.
- Not bad, but time-consuming, intrusive and very expensive and still no contemporaneous timekeeping information. When the IRS audits these types of Studies, they will also do in-person interviews with some of your staff/contractors to corroborate their time.
- Studies that use contemporaneous timekeeping data married to a project management system.
- THE GOLD STANDARD. The IRS Agent will often pass on doing any additional audit work and accept the amount of the R&D Credit.
As mentioned above, though, most startups do not have contemporaneous timekeeping info. If you are a software company you probably DO have this required project and timekeeping information in your version control system (GitHub). This is EXACTLY the information that the IRS wants to see in your Study.
A firm that we know well, eTaxConnect has an app whereby they are able to extract this git information and put it into a beautifully IRS compliant R&D Credit Study. They to do this efficiently, inexpensively and taking very little of your time or involvement. They have done a ton of Studies for YCombinator (YC) and other startup software companies.