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THE APRIL 18TH TAX DEADLINE IS APPROACHING FAST
DON'T FORGET TO CLAIM YOUR R&D TAX CREDIT! BOOK A CALL TODAY
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THE APRIL 18TH TAX DEADLINE IS APPROACHING FAST
DON'T FORGET TO CLAIM YOUR R&D TAX CREDIT! BOOK A CALL TODAY
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July 27, 2022
1 min read
By Neo.Tax Team
So you’re a startup and believe the best way to get the help you need to build your company is with independent contractors... hmmm, interesting.
It’s your company, so we’re not here to tell you how to run it, just that you’re missing out on up to $250,000 in research and development tax credits by not setting up payroll.
Yup, you heard that right. You could miss out on hundreds of thousands of dollars because you either haven’t set up payroll or you've set it up incorrectly.
Imagine what you could do with that money. Maybe:
Have no fear, Neo. Tax is here!
Check out our guide to setting up your payroll taxes as a startup or new business.
Let’s be clear: you can report independent contractors on your R&D tax credit claim.
The credit is a percentage of your QREs, also known as qualified research expenditures. These expenditures include in-house research expenses and contracted research expenses. Contract research expenses are handled a bit differently than in-house research. Only 65% of contractor research can be claimed–here’s an example of what that means:
Say I want to research sneaker materials as I’m developing an innovative new style of lifestyle shoe with posture support. I need to get some research from an outside firm; the cost is $100k. When reporting this expense for your R&D credit, only 65% of that independent contractor’s payment will count toward your credit claim. Essentially, $65k of this firm’s bill.
Now, let’s say you realize your needs exceed just research on materials and you contract the same firm to conduct an analysis of the sneaker market and who the target audience for the shoes will be at the same time. The cost is $250k; $100k for research on materials and $150k for the marketing analysis. Typically, marketing expenses are not qualified expenses for the R&D tax credit. This means you can only claim 65% of what you paid to the firm for R&D only–which, in this case, amounts to $100k of the $250k final bill.
The same calculation applies to percentages of time as well. Let’s say the firm bills hourly and states they dedicated 200 hours to R&D at $500/hour, which is one part of the final $250k bill from the firm. It’s then up to you to calculate 65% of those 200 hours that go toward your claim. Again, in this case, you could claim $65k of the firm's bill toward your R&D tax credit.
Remember: as a company that is not yet profitable, your R&D credit comes as a payroll deduction. This means that even if you’re employing independent contractors, you must set up payroll in order to receive your credit.
If you’re already working with an accountant or accounting firm, then they can handle all your payroll needs.
If not, think about getting a payroll provider like Gusto, or learning the ins and outs of payroll yourself.
After you’ve set it all up, find trustworthy R&D tax credit software to help you seamlessly integrate your payroll and accounting information to claim your R&D credit.
Want to learn more about R&D software? Check out our post about what to look for.
More often than not, setting up payroll boils down to these steps:
Now that you’re setting up payroll, it’s a good time to pay extra attention to the details of all your records. The IRS can be fickle, so it’s always better to stay ahead of your payroll filings. Here are some resources to help you along your payroll journey.
Forms:
Payroll can be one of the more complicated processes, making it extremely important to have a solid Payroll Dream Team that will help ensure your company payroll is done accurately and on time! If the ‘92 Men’s Olympic Basketball Team taught us anything, it’s that the Dream Team exists.
This is who you should have on your Payroll Dream Team:
Here are a few more tips for payroll:
Payroll is a fundamental part of claiming your R&D tax credit as a startup or new business. Set it up and watch the R&D credits flow in.
Trust us, it’s worth it!
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In July, the government moved for a summary judgment ruling that Kyocera AVX, the multinational ceramics and electronics manufacturer, is not entitled to the $1.3 million amended Section 41 R&D Credit they recently claimed. The company had hired PricewaterhouseCoopers (PwC) to make the filing, and the accounting firm did interviews with subject matter experts to compute the eligible amount of Section 41 credits they could claim for the tax years 2017-2020. PwC found $1.3 million worth of unclaimed credits, which they filed in the amended Section 41 study. But, ultimately, the IRS claims that the R&D Study and documentation provided were not sufficient to support the claim, and when the IRS requested additional documentation to support the claim neither Kyocera nor PwC could produce it.
Two of the government’s objections in its case against Kyocera are especially relevant to any company that files for an R&D tax credit: 1) “The PwC study exclusively relied on interviews to determine employees' time spent on projects; it did not use documentation” and 2) “Kyocera does not have a centralized system for tracking employee time, and generally does not track employee time on projects.”
The IRS has been emphasizing the necessity of contemporaneous documentation for decades, as far back as Eustace v. Commissioner in 2002. But this recent motion for summary judgment against Kyocera could mark a potential shift towards a stricter application of their long-standing policy.
The direction seems clear—reliance on after-the-fact interviews without supporting documents is increasingly untenable.
Kyocera's reliance on a PwC-conducted study, which was ultimately deemed insufficient by the IRS due to lack of proper documentation and over-reliance on estimates, highlights a systemic risk in the current practices of R&D credit calculation.
The IRS mandates strict substantiation requirements for claiming R&D tax credits under Section 41 of the IRC. Specifically, Treasury Regulation § 1.41-4(d) emphasizes the necessity for contemporaneous documentation to support the expenditures claimed. This documentation must detail the nature of the qualifying activities and their direct connection to the claimed credits—a challenging task for businesses relying on traditional methods, particularly for those that do not have employee time tracking systems in use.
In the case of Kyocera, the IRS disputed the R&D tax credit claims due to inadequate substantiation of the research activities claimed under Section 41. The agency focused on the lack of contemporaneous documentation, relying instead on retrospective estimates from interviews conducted by PwC long after the fact. This method was seen as inadequate in the eyes of the court; they demanded a more rigorous substantiation to prove that the activities qualified as R&D.
This is where Neo.Tax separates itself in the R&D tax space. Unlike traditional methods that often rely on after-the-fact recollections and manual calculations, Neo.Tax leverages advanced AI to analyze real-time data from integrated systems such as Jira and GitHub. This not only ensures greater accuracy but also provides a contemporaneous, auditable trail of documentation that meets IRS requirements. Better yet, our AI not only reviews these systems to identify the research activities, but also uses the meta data to help allocate the time. And because the meta-data is recorded "at the same time" as the tickets in Jira, it is — by definition — "contemporaneous documentation."
By accessing data from systems such as Jira and GitHub at the time of tax preparation, Neo.Tax’s platform can automatically extract, classify, and substantiate qualifying R&D activities. This method aligns with the IRS's emphasis on contemporaneous records. The agency prefers these types of records because they are more reliable than documentation created far after when the activity occurs — certainly, an engineer creating a timesheet of his work at the end of the month is likely more accurate than asking them to recollect their work on a project completed a year, or multiple years, in the past.
Unlike traditional R&D studies conducted by large accounting firms, which rely on retrospective interviews and questionnaires, Neo.Tax’s solution utilizes real-time data to support R&D credit claims. This direct link to project-specific activities minimizes reliance on employee recollection and significantly enhances the accuracy and defensibility of claims during IRS audits.
We often speak of the way our AI solution saves time for controllers, heads of tax, and engineers by eliminating the need for time-consuming retrospective interviews. But the Kyocera case highlights another, far more stark and costly risk of relying on memory and estimations for look-back claims. The IRS is making it clear that they’re emphasizing the need for contemporaneous data. Companies who rely on the R&D credit should take note.
As businesses increasingly adopt project-management tools that capture their developmental activities in real-time, a new approach to R&D tax credit documentation is possible. Neo.Tax’s AI-powered platform provides a reliable, efficient, and IRS-compliant method to claim R&D tax credits. By leveraging data directly from the systems so-often used by innovative companies, Neo.Tax ensures that your spending on R&D is rigorously documented in accordance with current tax laws.
We can get you the money you’re owed. Just as importantly, we can deliver the data-rich study that the IRS prefers and expects.
Given the importance of extending runway in today’s high-interest-rate reality, it’s shocking to learn that just 3 out of every ten companies that qualify for the R&D Tax Credit claim the money they’re owed. In 2011, “the largest 0.13 percent of all firms in the US claimed 14 percent of the credits,” according to research by the Mercatus Center at George Mason University. So, if you’re on the fence about claiming the credit, remember that the big guys are claiming it; shouldn’t you, too?
But this isn’t an article designed to make you feel foolish. FOMO Marketing is not our thing. We at Neo.Tax have built our AI-powered R&D Credit filing tool to make sure every innovative American business can claim the money they’re owed. So, get in touch with our team of experts to walk you through the process! And if you didn’t file for your credit last year (or the year before that, or the year before that…), don’t worry. We can help with that, too!
Many people don’t know this, but you can claim the R&D tax credit for the current tax year plus amend returns for the previous three tax years. For example, in 2023, you could claim credits for 2023, 2022, 2021, and 2020. That retroactive tax filing could be worth hundreds of thousands of dollars (or more) for your company. Neo.Tax doesn’t just stop at your prior three years, though. Due to the mechanics of the credit calculation, it may be beneficial to go back even further to substantiate qualified research activities to maximize the credit in your amended tax years. We can help with that – the lapsing of time is not a limiting factor to our technology! We know that’s getting very inside baseball; again, book a call, and we can talk you through it…
But even those who do know about the value of a Multi-Year Lookback R&D Credit often decide against filing because of the expenditure of time and effort to correctly calibrate the amount you’re owed. The big change with Neo.Tax is that by linking with your existing project-management system, our AI-powered tool can seamlessly identify qualified expenses from past years. What used to be difficult (or impossible, if enough engineers had moved on and are unreachable for interviews) is now quick, low-lift, and much more accurate than human memory could muster.
With Neo.Tax, it’s simple: if your company has a project management system that goes back x number of years, just plug it into Neo.Tax, and our groundbreaking tool can generate the projects and assign the effort for employees across each of those years. In solving for the pain of filing an R&D credit, we also built a tool to make Multi-Year Lookbacks painless and worth it for every innovative company.
The big guys have been claiming it for years. Now’s the time to claim it too.
