Founder's Guide to Tax Credits

The government offers many tax credits to help startups offset research and development costs, hiring employees, and more. Most startups don't know that certain credits offer direct cash back from the IRS — even if the company does not have any profits or owe any income taxes. This guide will discuss the most beneficial tax credits for startups, how to qualify, and how to claim them.

Tax Credits are government incentives intended to encourage innovation, hiring, and growth of the US economy. There are thousands of tax credits, but only some are useful for startups. Most credits are only valid for companies that owe income taxes, but since startups are generally not turning a profit in their early days, the other credits are not so useful. The most critical tax credits that offer direct cash back from the IRS, regardless of whether the company owes income tax. There are two tax credits that every startup needs to take advantage of.

The two most valuable tax credits for startups are the R&D Tax Credit and the Employee Retention Tax Credit.

The R&D Tax Credit is a tax credit for startups that invest in research and development — which includes all startups with engineers, designers, product managers, and founders on payroll. The credit is intended to encourage businesses to invest in innovation and new technology. The credit can be claimed against income tax or payroll tax. Most startups claim it against payroll tax, which makes this credit refundable — your startup gets a check directly from the IRS.

The Employee Retention Tax Credit (ERTC) is a tax credit available to eligible employers who retain their employees during the COVID-19 pandemic. The ERTC is a refundable payroll tax credit companies can claim on eligible employee wages and healthcare costs. It was designed to reduce layoffs by offering relief for those who kept employees on the payroll through their financial hardships. And even though it’s come to an end, it’s well worth exploring if you didn’t take advantage of it already. If you qualify, you can apply the rules retroactively. And save yourself from losing out on the chance for some financial relief.

To qualify for these tax credits, your business must be registered with the IRS and be up to date with your corporate tax filings. Missing a corporate tax deadline could disqualify you from some of these valuable credits. Both the R&D Tax Credit and the ERTC have different qualification criteria which we will review in detail below.

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As we discussed earlier, there are two ways to claim the R&D Credit, the method that is most advantageous to startups is via the payroll tax credit. Eligible startups include those that

• Are developing new or improved products, processes, software, algorithms, formulas, or inventions
• Have under $5 million in gross receipts in the current year
• No more than 5 years of generating gross receipts, including the current year.
• Have employees or contractors in the United States

Your startup can get up to $500,000 per year from the R&D Tax Credit. To see if you qualify and how much you can get back see here: tryfondo.com/credits-check

The ERTC was originally only available to eligible employers who retain their employees during the COVID-19 pandemic. The American Rescue Plan Act (ARPA), passed in March of 2021 expanded the ERTC. ARPA added new eligibility for "Recovery Startups". It allows businesses that started operations during the pandemic (and thus weren’t around in 2019) to compare 2021 earnings to revenue for the same quarter in 2020. And it permits qualified startups to claim credits for the third and fourth quarters of 2021. Further, it allowed recovery startups to be eligible for relief even if they didn’t experience a government mandated shutdown or the required revenue decline so long as the startup:

• Began operations after February 15, 2020
• Have an annual gross receipts of $1 million or less

For wages paid between January 1, 2021 and September 30, 2021, the credit increased to equal 70% of qualified wages up to $10,000 per employee each quarter. That means you can claim up to $7,000 per employee per quarter, meaning you could claim a maximum of $21,000 per employee for 2021. Fondo can help you determine all of these qualifications, calculate the maximum amount you can get back, file the additional forms with your corporate tax return, and make the necessary updates your payroll system to ensure you are getting your cash back from the IRS. If that is helpful, you can get started here (tryfondo.com/credits).

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Below are the things you will need your accountant to complete in order for you to claim and receive these credits.

How to claim the R&D Tax Credit

This credit is claimed by doing an R&D Credit Study, filing additional forms (Federal & State) with your corporate tax returns, and updating your payroll system. Fondo would love to help you with this, you can sign up here.

How to claim the ERTC

Advanced payment of the credits was available for qualified employers looking to boost cash flow throughout the year. You would have needed to fill out Form 7200, Advance of Employer Credits Due to Covid-19 at the beginning of the tax year.

Alternately, if you’re eligible, you could have claimed the new Employee Retention Credit by calculating your total qualified wages (including any health insurance costs) for each quarter. You then subtract that total from your deposit on Form 941, Employer’s Quarterly Federal Tax Return.

If you haven’t already claimed credits, you can do so retroactively by filling out Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund for the quarter or quarters in which you paid qualifying wages.

Fondo would love to help you with this, you can sign up here.

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The government offers a number of tax credits that can help startup businesses offset the costs of research and development, hiring employees, and more. By taking advantage of these credits, you can save your startup money while you invest in growth.

To ensure you are maximizing your tax credits amount and doing everything correctly, it is best to work with a professional. Fondo helps over 300 startups with this each year and would love to help your startup! Fondo can help you determine all of these qualifications, calculate the maximum amount you can get back, file the additional forms with your corporate tax return, and make the necessary updates your payroll system to ensure you are getting your cash back from the IRS. If that is helpful, you can get started here (tryfondo.com/credits).