R&D Tax Credits: A New Non-Dilutive Funding Source For Startups

3 Mar

By Jacob Setterbo, Director of Grants, HIREtech

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Startups can now benefit from both grants and R&D Tax Credits

The R&D Tax Credit was created by Congress to encourage R&D investment within the United States. In the past, however, R&D credits were only available to companies that are profitable, as companies that have yet to turn a profit had no tax burden to be reduced by the credits. It seemed unfair that life science startups, which primarily perform R&D but typically pay no income tax for years, could not benefit from the R&D Tax Credit (FIGURE 1).

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FIGURE 1: In the 2015 tax year, there is limited eligibility for the R&D Tax Credit.

This disparity between profitable companies and startups has finally been resolved, and startups can finally benefit from R&D Tax Credits. The gap was closed by the PATH Act, signed on December 18, 2015 (FIGURE 2). In addition to making the R&D Tax Credit permanent and allowing it to be applied against the Alternative Minimum Tax (AMT), the PATH Act allows startups to use the R&D Tax Credit to offset payroll taxes for up to 5 years. This change is particularly beneficial for life science startups, because it often takes several years before their income exceeds their expenses. Plus, everyone has to pay payroll taxes!

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FIGURE 2: In the 2016 tax year and beyond, even startups are eligible for the R&D Tax Credit.

Grants and tax credits are similar in that they are non-dilutive (you don’t lose equity) and you don’t have to pay them back. Their main difference is that grants are forward-looking whereas tax credits are backward-looking. For grants, you have to convince reviewers (often professors) that your proposed future project is significant, innovative, and will have a great impact on public health. The national “success rate” for SBIR/STTRs is typically somewhere around 15-20%. For tax credits, you just have to be able to prove that you performed R&D the previous year. While you must confirm your eligibility, understand what is considered “qualified research expenditures,” and know how to calculate the credit, I can assure you that the “success rate” for R&D Tax Credits is near 100% if you follow the rules.

As a life science entrepreneur, it is in your best interest to seek various funding sources. Grants are an excellent source of non-dilutive funding that can push your project forward, but, as noted on www.sbir.gov, they are “highly competitive.” Fortunately for startups, the new R&D Tax Credit rules allow you to offset your payroll taxes if you perform R&D in 2016. Like grants, these tax credits are non-dilutive, but, unlike grants, they are nearly a sure bet when calculated correctly.

Jacob will be presenting an upcoming RESI Workshop on R&D Tax Credits at RESI@TMCx in Houston on April 11. View the full RESI agenda here.

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