Launching a new business often comes at a steep price, and startups in the early stages are likely looking for ways to save money. Fortunately, there are several actions startups can take to reduce costs, including claiming tax credits, tax deductions, streamlining operations, and planning for growth and investments.
Tax credits are an excellent way for startups to save money when starting, as they reduce tax bills. For example, if you owe the IRS $10,000 and receive a tax credit of $2,000, you will only need to pay $8,000 in taxes.
R&D Tax Credits
Many tax credits are available to startups, including research and development (R&D) tax credits, which are available to companies that engage in activities to design, develop, and improve the functionality of their products. Congress enacted the R&D tax credit in 1981 to encourage companies to invest more in research and development and keep technical jobs in the country, a response to declining innovation among American businesses in the 1970s.
The federal government has made R&D tax credits more accessible through changes enacted in 2003 and 2015. In 2003, Congress eliminated the “Discovery Rule” that required R&D to be groundbreaking discoveries previously unknown to the world. In 2015, the Protecting Americans from Tax Hikes Act (PATH Act) was signed into law, making the R&D tax credit a permanent part of the tax code and eliminating the Alternative Minimum Tax (AMT) for businesses with $50 million or less in gross receipts.
R&D tax credits are easily accessible to startups because many industries can qualify for them. Contrary to popular belief, research and development does not need to be successful to count as a QRA, it only needs to attempt to improve a business component and be new to the company. There is a broad range of eligible qualifying research activities, including those not traditionally viewed as research and development, such as improving food taste or implementing user-friendly features on an ecommerce site.
In addition to the federal R&D tax credit, many states offer a state-level credit that business owners can claim alongside the federal-level credit, providing an additional opportunity to save money on research and development.
Qualified Small Business Stock (QSBS)
Under the Qualified Small Business Stock (QSBS) provision in section 1202 of the IRS Code, investors who own QSBS may be able to eliminate tax on some or all of their gain from the disposition of their stock. Those who sell QSBS can eliminate some or all of their federal income tax gains of up to $10 million.
There are several criteria businesses must meet for the QSBS tax credit. First, organizations must be a C corporation with assets of $50 million or less before and after the stock is issued. In addition, a business must be classified as a technology company, manufacturer, retailer, or wholesaler. Moreover, the stock must have been acquired in exchange for money, property, or as compensation for services. Lastly, you must hold the stock for over five years.
Another method for startups to save money is tax deductions. Tax deductions are expenses companies can subtract from their taxable income before calculating their tax bill. Companies can claim several tax deductions, including business expenses and first-year startup and organizational costs.
Business expenses include day-to-day operating expenses, including office supplies, internet, and vehicles. In addition, expenses such as advertising, site selection (money spent selecting a location to work from), training wages, and consultant fees also qualify for tax deductions. As long as the expense is directly connected to running the business, it will likely qualify for a tax deduction.
The startup tax write-off allows new businesses to deduct up to $5000 of business startup and $5000 of organizational costs incurred during the first year of operation. Organizational expenses include state and legal fees required to open a business.
Many organizations may ask themselves how to improve business efficiency and streamline operations. There are several methods to remove unnecessary steps and simplify workflows, including implementing project management software, automating processes, and reducing paperwork.
One way to streamline operations is to invest in project management software to simplify multiple tasks. For example, a company without project management software is likely to spend more time delegating tasks, allocating resources, forecasting, and managing collaboration. Project management software can provide a platform for managers to perform these responsibilities and more easily meet budget, scope, and quality expectations.
Further, it is essential to review workplace operations constantly to find improvement areas. Reviewing workplace operations to determine if there are technologies to upgrade, processes to improve, and ways to boost productivity among employees. For instance, if your business is using paper to issue invoices and keep track of expenses, you can consider making these tasks digital by emailing invoices and using expense tracking software to monitor expenditures. Digitizing these tasks can save your business money on paper while making employees’ jobs easier.
Businesses that streamline workflows are more likely to see increased employee productivity while saving time and money on day-to-day tasks.
Planning for Growth and Investments
Many startups do not survive longer than a few years due to the lack of long-term planning. While business growth and investments are desirable, it is crucial to have a growth plan that can help identify strategies to achieve business goals. A growth plan can provide a benchmark for investing by indicating when to onboard new staff, create new partnerships, and implement product expansion strategies.
One of the key aspects of growth planning is to save money on overhead costs such as office space expenses. Choosing alternatives to traditional office space can help your organization through financially tight early years while saving substantial money on overhead. During the early stages of a startup, one of the ways you can save money is to work-from-home if possible. Another alternative to purchasing or leasing traditional office space is to use a co-working space.
With multiple ways for new businesses to save money, starting a new company does not have to break the bank. MainStreet’s tax specialists help startups find all the R&D tax credits they qualify for and estimate how much they can save. If your organization is looking to cut costs by claiming R&D tax credits, contact us today.