5 Bountiful Ways to Reap R&D Tax Credits for Your Software Startup

Written by Taz Singh, CPA. Updated Apr 16, 2019.

RD_SoftwareStartupWhen I hear or see the term “start-up,” for some reason my mind’s eye conjures images of fragile, slender vegetable plants that have just recently tunneled their way up through the dirt and into the light. They’re teetering just inches above the soil, still closer to their origin than their destination. At this stage, they require attentive care to afford them every advantage to grow and prosper.

Software startups are much the same. As a budding business, they require skillful management – including wrangling any money-saving opportunities to invigorate their growth potential and fertilize their delicate bottom-line. Taking advantage of R&D tax credits is one way that startups can harvest significant savings.

Learn More about Decreasing Small Business Tax Liability with the R&D Tax Credit

Let’s look at the ways new software companies can capture R&D credits to pollinate their monetary potential:

5 R&D Tax Credit Opportunities for Software Startups

  1. The Software Itself
    The Internal Revenue Code (IRC) considers software a viable business component for R&D tax credit claims. But not just any software will do. All must first pass an initial four-part test. If the software is internal-use software, then the IRC requires the evaluation of an additional three-part test to qualify.

  2. At the Base
    The IRC offers R&D tax credits to businesses that increase their research and development activities and expenses beyond their past expenses. This “base period” is calculated using either a historical 80’s period or start-up method.

    Startups are held to a three-percent fixed-base for their first five years of operation. To calculate their base amount, the three percent is then multiplied by the company’s average gross receipts for their prior four years.

    Any current-year expense above the base period can receive a federal tax credit equaling 20% of the incremental qualified research expenses (QREs). The IRC caps eligible R&D expenses at 50%.

  3. Alternative Credit Style
    The Alternative Simplified Credit (ASC) allows software development startup businesses to capitalize on a less complicated calculation to reap R&D tax credits. The ASC only factors in the three previous years’ QREs to tally the base period.

    This alternative method provides the potential for a company to recognize a credit that may have been limited or eliminated by using a historical 80’s period or start-up method base.

  4. High-Five for High-Level Executive Wages
    The IRC allows credits for wages of executives who oversee employees who directly engage in or supervise qualified research activities.

    It’s no secret executives and supervisors typically hold higher salaries and bonuses than first-line employees. Neglecting to claim qualified direct supervision wages means losing out on substantial tax credit savings.

  5. Less is More
    Recently in 2016, new tax provisions permitted startup companies an opportunity to offset their corporate payroll taxes – which can add up quickly when employing skilled researchers and developers.

    Startups can qualify for up to $250,000 in credit each year if they’ve produced less than $5 million in gross receipts for the year in which they are claiming the credit. This affords new, struggling or emerging software businesses to maximize their tax saving potential.

Sow the Seeds of R&D Tax Savings with CTI

All software startups deserve every opportunity to grow and prosper, which includes leveraging every opportunity to save money. The R&D tax credit is an option not to be overlooked – it’s a viable opportunity for startup businesses to gain tax relief.

Partner with CTI’s team of elite CPAs, engineers, attorneys, and scientists that possess the expertise and acumen to capture optimal tax credit potential for any new software development company.


What Can R&D Do For You?  Discover a practical approach to maximizing your federal research and  development tax credit. Download Guide

Topics: R&D Tax Credit

Taz Singh, CPA

Written by Taz Singh, CPA

Taz has 20 years of experience in tax and business incentives. Prior to establishing CTI, Taz served as a corporate tax auditor for the California Franchise Tax Board. During his tenure, Taz specialized in auditing tax credits, including manufacturers’ investment credits, research & development credits and credit limitations (IRC 382 Limitation) due to ownership changes.