Establishing a startup can be expensive, and saving money on operating costs is likely a top priority for many small business owners. Fortunately, startups can take advantage of many tax credits to help reduce business costs. Furthermore, a startup does not need to be profitable to qualify for tax credits. We’ll review some of the typical tax credits startups can claim.
R&D Tax Credits: The research and development (R&D) tax credit is available to companies that engage in activities to design, develop, or improve products for improved quality, reliability, and functionality. There are R&D tax credits at the federal level, and over 35 states offer state-level credits.
Federal R&D tax credits are one of the easiest for companies to claim as the criteria for what qualifies as R&D is very broad. While laboratory activities can qualify for this credit, several activities across a wide range of industries may qualify as R&D, such as improving the taste of food and drinks, developing new computer game titles, or making a manufacturing process more environmentally friendly.
If you live in a state that offers state-level R&D tax credits, you can double dip and increase your savings by claiming federal and state credits. State credits generally have similar criteria for what counts as qualifying research activities as federal credits. However, you will have to apply for each separately, and each state has different criteria for claiming its local credits. While the application process can be daunting, our R&D tax credit experts help startups claim every credit they are eligible for.
Qualified Small Business (QSB) Tax Credit: A QSB is a startup that is a domestic active C corporation whose profits do not exceed 50 million on or after the issuance of Qualified Small Business stock. QSBS refers to shares of a qualified small business stock acquired after August 10, 1993, as defined by the IRC (Internal Revenue Code). To claim this tax credit, a small business must meet the following criteria:
- The investor must have acquired the stock at its original issue and not at a secondary market.
- Stock must have been bought with cash or property, not accepted as payment
- Investors must have held the stock for at least five years
- At least 80% of the issuing corporation’s assets must be used in the operations of one or more of its qualified trades or businesses.
In addition, only businesses in specific sectors may qualify, including technology, retail, manufacturing, and wholesale.
Furthermore, owners of QSBS can qualify for tax-free capital gains on their federal taxes for up to $10 million of realized gains.
Small Business Healthcare Tax Credit:
The Small Business Healthcare Tax Credit allows small businesses that offer a qualified health plan to their employees through the Small Business Health Options Program (SHOP) to receive a credit of up to 35 or 50% of their employee’s premiums if they are tax-exempt or not, respectively. To qualify for this tax credit, businesses must:
- Pay at least 50% of the cost of employee-only, not family or dependent healthcare coverage for each employee
- Have less than 25 full-time employees
- At least one employee must not be the business owner’s spouse, partner, or a co-owner
- Employees must be paid an average of $56,000 or less as of 2022. However, this is indexed annually for inflation
- Offer SHOP health plans to all employees
This tax credit works on a sliding scale, so the smaller the business, the higher the tax credit. While it is possible to qualify for this tax credit without using SHOP, it is more difficult to claim it without SHOP.
Although small businesses are not required by law to provide their employees with health insurance, the Small Business Healthcare Tax Credit makes it easier for startups to do so, leading to greater employee satisfaction and reducing turnover-related expenses.
Family Leave Tax Credit:
The Family Leave Act Tax Credit (FMLA) is a dollar-for-dollar tax credit available to employers that pay their employees who are on away on family and medical leave. This tax credit ranges from 12.5 to 25% of employee wages. It increases by 0.25% for each percentage point that exceeds 50%. The Taxpayer Certainty and Disaster Relief Act of 2019 has extended the credit until the 2025 tax year. To qualify for the credit, businesses must meet the following requirements:
- Have a written policy in place
- Offer paid FMLA to all employees
- Provide at least two weeks of paid FMLA
- Pay at least 50% of the employee’s wages
In addition, you must make sure your state or city does not mandate paid FMLA. If your state or city requires paid FMLA, you will not be able to claim the FMLA tax credit.
Earned Income Tax Credit:
The Earned Income Tax Credit (EITC) offers low and moderate-income families a tax break. The amount of credit depends on marital status and the number of children. Sometimes, the EITC can refund you more than the taxes you paid. Moreover, you don’t have to have children to qualify for this tax credit. By law, the IRS cannot issue your refund until mid-February if you claim the Earned Income Tax Credit.
Work Opportunity Tax Credit:
The Work Opportunity Tax Credit (WOTC) is available to startups that hire and retain people who historically face barriers to employment, including:
- Summer youth employees,
- Supplemental Nutrition Assistance Program (SNAP) and Supplemental Security Income (SSI) recipients
- Qualified long-term unemployment recipients
- Vocational rehabilitation referrals
- Designated community residents (DCR)
Employees who are not eligible include family members, rehired employees, or someone who will be a majority owner in the business, even if they otherwise fit into any qualifying groups.
WOTC is available to any startup regardless of industry or income. There is no limit to the amount of WOTC a business can claim, as it depends on the number of qualifying employees.
Industry-Specific Tax Credits:
In addition to the tax credits available to a broad range of industries, several more are available to startups in specific industries.
Conclusion: Considering the sheer amount of tax credits available, it can be daunting for startups. MainStreet has expertise in searching for R&D tax credits for small businesses and helps them claim each one they are eligible for. Ask us how we can help!