As we near the extended deadline for tax filing – May 17 for most, June 15 for those affected by Texas winter storms – you’re inevitably wondering if you’ve explored all your options for tax credits and deductions. Especially if you’re a tech founder, the first few years of filing taxes for your startup can be critical in sustaining growth and avoiding penalties later on.
Whether you’re navigating taxes on your own or with a CPA, these are five tax credits that startup founders need to be aware of, and planning for, in filing their annual tax returns. Even if you’ve already filed your 2020 tax returns, many of these will still be applicable for 2021.
Employee Retention Tax Credit
The Employee Retention Credit (ERC), under the CARES Act, is helping startups and small businesses mitigate their losses from keeping employees on payroll throughout the COVID pandemic. Any startup that has employees and is paying wages can qualify for the ERC if you have a reduction in revenue or if you had operations completely or partially shut down due to a government order. You may remember that PPP loan recipients were ineligible for the ERC for most of 2020, but that changed in December and employees can now claim the ERC even if they received a PPP loan.
To submit for this credit, you’ll need to prepare quarterly income statements from 2019 to present, payroll reports (Form 941) and a list of salaries by employee. You’ll be able to claim up to $5,000 per employee per year for 2020. In 2021, you’ll be able to claim up to $7,000 per employee per quarter. Most founders don’t realize that once you meet the revenue decline requirements in 2021, you are automatically eligible for the following quarter’s credit. In some cases, you may be eligible for the tax credits even without a revenue decline. You can read more about the employee tax credit qualifying tests here.
R&D Tax Credit
The R&D Tax Credit is available to any business that creates new or improved products, processes or techniques. Yes, that’s broad, and yes, that works in your favor as a tech startup.
To submit for this credit, you’ll need your prior three years financials, details on which of your employees spend time on research & development activities, and a list of qualified business expenses that are directly related to R&D. If you think those QRE (Qualified Research Expenses) total at least $50,000, it’s worth getting the information together to claim this credit.
Many startups aren’t aware that their R&D tax credit can also reduce payroll taxes. This is especially helpful for C-Corp startups that are pre-revenue or not yet profitable. The income tax credit can only offset income tax, but the payroll tax credit can offset payroll tax deposits that startups are already making.
Retirement Plans Tax Credit
The IRS recently increased the Retirement Plans Startup Costs Tax Credit to incentivize companies, especially startups, to offer retirement plans. If you have less than 100 employees who received at least $5,000 from you in 2020 and you’re still in the first three years of offering a retirement plan, you’re eligible. You’ll need to summarize your costs in setting up and managing the plan, in addition to costs incurred educating employees about the retirement plan, and use Form 8881 to claim the credit.
Work Opportunity Tax Credit
This is a tax credit that is often missed because employers don’t ask the right questions when hiring. In their defense, it’s hard to navigate these questions and hard to know what’s appropriate to ask. The Work Opportunity Tax credit is a federal tax credit available to employers who hire individuals from targeted groups, such as qualified veterans, ex-felons, long-term family assistance recipients, those in qualified economic empowerment zones and others – you can view the full list here. Many CPAs, us included, work with third parties that can identify employees that are eligible and determine the tax credit on behalf of your company. This is done in a confidential manner and can be added to the normal hiring process.
Small Business Healthcare Tax Credit
This tax credit is not as common but most often applies to startups and small nonprofits. If you have less than 25 full-time employees that make an average of $50,000 or less, and you pay 50% of their health insurance premiums, you can claim a tax credit for up to 50% of your costs. If you’re a non-profit, you can claim a tax credit for up to 35% of your costs. To qualify, you have to be paying healthcare premiums, purchased through the healthcare.gov marketplace, for full-time employees, not including dependents or part-time.
While this isn’t a tax credit, it’s a huge tax deduction opportunity for startups. Many new and used business assets, including nonresidential property improvements, certain vehicles, machinery, computer hardware and more, can qualify for bonus depreciation. This means startups can expense, in the year the qualified property is acquired, 100% of the cost as depreciation and significantly increase their deduction. Bonus depreciation is set to drop down to 80% starting in 2023 and will fall to 20% by 2026 based on current law.
We work with many startup founders and tech entrepreneurs building the next generation of product and service businesses. It’s one of the best parts of being headquartered in Austin. If we can help you navigate tax planning, manage annual filing or serve as tax advisors as your business grows, contact us today.