8 Reasons Your Tech Startup Shouldn't Pay 20% R&D Tax Credit Fees

Facts: There’s been a proliferation of R&D tax credit providers in the last several years. Most of these newcomers offer their services in exchange for a set percentage of your R&D tax credit - they take 20% of your tax credit as part of a “contingent fee” arrangement . What’s more, they charge the same fees regardless of how simple the client’s R&D credit might actually be to document and calculate.

The IRS guidelines, regulations, and case law are indeed voluminous and highly nuanced. Compliance with these rules typically requires guidance from tax experts with deep knowledge of and experience with the R&D credit criteria.  

As such, most companies looking to claim the R&D credit find they really do need a consultant with deep knowledge of the rules. They need an expert who can ensure they are compliant, be efficient in their engagement, and maximize the tax credit to which their business is entitled (i.e. not leave dollars on the table).

But tech startup R&D studies are often much more straightforward than those of more complex businesses who’ve been around for many years. It begs the question, “Should we really be giving up 20% of our tax savings for this service?"

To help you answer that question for yourself, below are the general factors that make calculating any R&D tax credit more straightforward.

8 Reasons Your Tech Startup Shouldn't Pay 20% R&D Tax Credit Study fees

Founders, if your startup meets most or all of these criteria, it is highly likely that your R&D study is on the simple end of the spectrum and you shouldn't be paying 20% of your tax credit for it.

1.  It is readily apparent that your team’s engineering activities meet the Four-Part Test, summarized as:

1. You’re developing a product you intend to sell or you’re improving a relatively new, existing product in terms of quality, performance, reliability or functionality.
2. There are technical uncertainties from the outset of the project regarding the appropriateness of design, capabilities, or method.
3. Resolving the technical uncertainties requires a process of experimentation.
4. The work is technological in nature.
   

2.  Your business has been in existence for fewer than 5 tax years.

Why? The tax credit calculation is relatively basic for businesses younger than 5 years.

3.  You’re an early-stage startup whose engineering activities are primarily focused on development or improvement of the first product you’re bringing to market.

Bonus points if you've yet to release your first product commercially. That's a great indicator your engineering team's work was likely eligible R&D.

4.  You have not acquired a major portion of any other trades or businesses.

Acquisitions add complexity to most tax-related matters, R&D credits included.

5.  You are not part of a controlled group.

This one’s a little tricky because the term “controlled group” is a term of art in the R&D tax credit world. Your startup is part of a controlled group if five or fewer owners of your company own greater than 50% of your business and own greater than 50% of any other businesses.



6.  The size of your organization is relatively small.

What do we mean by relatively small? Generally, if one or two individuals (i.e. managers or subject matter experts) have a deep understanding of (and can attest to) the research activities performed by the rest of the engineering team.



7.  No portion of the R&D work you are performing is considered “funded research.”

Generally, your engineering is not funded in whole or in part through contracts or grants with third-parties. No, venture capital funding is not what we're referring to here.




8. You can readily point to contemporaneous documentation that is generated through the normal course of your operations that support the nature of the qualifying development/improvement activities.

For reference, here's a checklist in Google Sheets that you can leverage in any discussions you may have with current or prospective R&D tax credit providers. 

The risks of working with contingent-fee providers:

In addition to running the risk of overpaying for a service that’s relatively straightforward, the contingent fee arrangement itself incentivizes providers to ensure your credit is as large as possible to maximize their own fees. While this may sound like a positive for your startup, consider the risk of having your credit scrutinized in the event of an IRS audit. Would you be able to defend such a large research expense amount? This should absolutely give one pause.  

Case In Point

There is at least one well-known R&D tax credit provider who actually sets the default qualifying percentage for every employee of every client at effectively 100%.  Then they put the onus on the subject matter expert at the client company to move those percentages down. And they do this without providing much in the way of substantive guidance on what constitutes qualifying research activities as defined by the IRS. It’s obvious why a contingent-fee provider would take such an approach.

To be clear, we’re not suggesting this practice is commonplace. But it’s an example of the risk you could be exposed to if you work with a provider who is being paid on a contingent fee basis.  

The TaxCredit.ai Difference
We take an empirical, data-driven approach to R&D studies. Our objective is to maximize your tax credit to the extent we believe we would be able to defend it down to the dollar under an IRS audit.

Our engagements with tech startups are driven by your team’s existing data from popular tools like GitHub, GitLab, Azure DevOps, Jira, Asana, Trello, and similar platforms (see how it works). Using your engineering team’s data serves three purposes:

1. Contemporaneous records are the IRS gold standard for research activity substantiation.
2. By running a machine learning analysis of your data to calculate how much of each person’s time was spent on qualified research activities, we’re able to automate about 80% of the work required in a traditional R&D study (and importantly, a comprehensive one; unlike those described above) asynchronously, without any time required by your leadership.
3.  By automating 80% of the work required- for you and us- we're able to charge much more reasonable fees than most providers. See our straight-forward R&D Study pricing here.  

Our goal is to get your R&D credit correct and create a research activity report that would speak for itself under audit. Maximize your credit, minimize audit risk.