Maximizing Your R&D Credit as an ERC Recovery Startup Business
July 27, 2022
At a glance
- The main takeaway: ERC recovery startup businesses aren’t excluded from claiming the R&D Tax Credit, but strict rules prevent companies from receiving double benefits.
- Impact on your startup: The right strategy could help you maximize both credits and increase cash flow by reducing your payroll tax liability through fully refundable credits.
- Next steps: Schedule a consultation with our R&D Tax Credit experts to explore your eligibility for the R&D and ERC credits and build a holistic tax strategy that’s right for your business.
The full story:
The 2021 American Rescue Plan Act extended the Employee Retention Credit (ERC) to a new category of eligible employers, dubbed “Recovery Startup Businesses.” The qualifications for Recovery Startup Businesses were broader than previous ERC eligibility requirements, including any company that began carrying on a trade or business after February 15, 2020, with average annualized gross receipts for the 2020 tax year of $1,000,000 or less, as confirmed in IRS Notice 2021-49.
Recovery Startup Businesses faced the unique challenge of launching new products or services while persisting through the unprecedented impacts of COVID-19. Qualifying for the ERC provided one tool for improving economic security, but it’s not the only option available. As startups, many of these businesses were also in the early stages of developing and refining products and processes, which are activities that typically qualify for the R&D Tax Credit.
Unlike the ERC, the R&D credit is permanent and a benefit that companies can rely on and budget for annually. However, the IRS imposes different standards for what constitutes a startup company for the R&D credit. While the qualifications for a startup for purposes of the ERC are quite broad, qualifying as a startup for the R&D credit can vary according to a company’s unique fact pattern, impacting how the credit can be utilized and requiring careful analysis by a tax advisor.
How the ERC and R&D credit overlap – and how they don’t
For companies that meet the IRS’s definition of a startup, both the ERC and the R&D credit are refundable tax credits that can provide immediate cash benefits to qualifying businesses. The credits are also similar in that they are both calculated using employee wages. The ERC is based on employee compensation and health care costs paid for by the employer. Wages also often make up a significant portion of companies’ R&D credit calculations (in combination with other types of costs). Additionally, startups have the ability to use both the ERC and R&D credits to reduce payroll tax liability in certain situations.
Because of these similarities, there are strict restrictions in place to prevent companies from cashing in on a double tax benefit by taking multiple tax credits on the same dollar spent. A business can qualify for and claim both the ERC and R&D credit as a Recovery Startup Business, but it cannot use the same employee wages to calculate both, specifically for the 2021 tax year.
Startups claiming the ERC and R&D credit should tread carefully (and strategically)
If your startup claimed the ERC during the 2021 tax year and also plans to claim the R&D credit for the 2021 tax year, the company cannot use the same wages to calculate both credits. Because the ERC has a higher net benefit of 70 cents on the dollar for qualified wages, it is more advantageous to prioritize the ERC and subsequently adjust the R&D credit by excluding any employee wages used to calculate the ERC.
However, this requirement leaves room for thoughtful strategies to maximize both credits while remaining within the confines of IRS regulations. For example, because the R&D credit only includes wages paid to employees performing qualified R&D activities, startups can potentially maximize the value of both credits by isolating wages paid to employees performing R&D from employees not performing R&D. If a startup calculates its ERC credit using only compensation paid to non-R&D employees, then there is no potential for a double benefit that would reduce the R&D credit.
There are other strategies available to optimize these credits, but all such strategies and calculations require careful analysis and strategic planning by a skilled tax advisor who can help ensure the credit claims remain compliant with the intersecting tax laws.
The bottom line
The R&D Tax Credit and the ERC for Recovery Startup Businesses both provide invaluable benefits to startup companies needing to increase liquidity – the ERC alone could help startups claim a potential value of up to $50,000 per quarter for Q3 and Q4 2021 – but these tools must be deployed thoughtfully. IRS regulations preventing a double benefit means the calculation of these credits could get complicated fast, requiring a procedure and strategy best left to experts.
Aprio’s R&D Tax Credit team has been collaborating with our renowned ERC advisors since the introduction of the ERC credit. Schedule a consultation with either the Aprio ERC team or Carli Huband to learn how we help startups maximize credit values while minimizing the risk of noncompliance.
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About the Author
Carli is the partner-in-charge of R&D Tax Credit Services at Aprio. Carli has dedicated the last five years to performing R&D Tax Credit studies for clients in a variety of industries, with a specialty in the manufacturing and technology industries. She has worked to prepare R&D Tax Credits for companies ranging from startups to Fortune 500 businesses, performing technical interviews with subject matter experts, calculating complex credits and preparing technical reports.
Justin Elanjian, CPA, is the Partner-in-Charge of Aprio’s Paycheck Protection Program (PPP) & Employee Retention Credit (ERC) Services. As a national PPP expert, prominent speaker and strategic business advisor, Justin helps both lenders and borrowers navigate the complexities of the PPP. He also helps his clients realize benefits from other stimulus package programs, such as the ERC, and is committed to strengthening his clients’ balance sheets and helping them achieve what’s next. Justin also leads a team of more than 50 professionals who share his passion for helping businesses maximize the federal COVID relief programs.