A detailed case study by Ashton Chanana, Director, Business Strategy & Advisory; Tax Credits & Incentives at Tax Hack Accounting

Whether business is up, or business is down, free money is free money.

When COVID peaked, and the government gave out free loans that you didn’t have to pay back. Was there any reason not to take this free money? 

When you consider that much bigger, richer businesses said yes to these funds, not taking the money put smaller companies at a strategic disadvantage. 

Many of our clients regularly do work that qualifies them for significant tax credits that directly offset taxes owed or generate a tax refund. Is there any reason not to take advantage of this either?

The Research and Development (“R&D”) tax credit helped many of our clients stay afloat during business downturns. Businesses can also use the credit to avoid paying large tax bills in strong growth years, and it provides an excellent incentive to continuing innovating each year. 

Here are some examples of how the R&D tax credit benefited our clients:

>> Check out our R&D tax credit calculator here and see how much you can save <<

Company 1: $2M Digital Marketing Agency with 15-20 employees

This client historically had an exceptionally high payroll. Total costs made up nearly eighty percent of sales in some years. In addition, the company consciously extended these costs as they stretched to take on new business. 

The firm planned to retain top talent to prepare for rapid growth down the road. However, once the pandemic hit the business world, its clients began to delay their invoices. It wasn’t long before the lightened cash flow left the company with a large amount of accounts receivables. 

Revenue appeared normal on an accrual basis, and the staff kept working. However, it wasn’t long before this client found itself in a cash crunch. Basic accounting showed that their cash on hand and projected cash flow was well short of the next payroll run. As a result, the firm was forced to consider the possibility of laying off 10+ employees temporarily.

The company had two choices: allow employees to apply for government benefits or keep them on the payroll. Management started to think that allowing its people to take advantage of unemployment insurance was the best option. Fortunately, quick government action via the CARES Act and EIDL program gave them the fast cash they needed. The government money gave the firm the money it needed to cover its payroll and wait for its receivable accounts to catch up. Ultimately, the client managed to hold onto most of its staff. 

The COVID relief loans gave the client the breathing room they needed to stay afloat with their current staff for the next six months. However, after the money ran out, they were in the same boat. Luckily, the intellectual property used in the firm’s technology and processes used in various projects gave them an out. 

How We Helped

Our team got them a significant R&D tax credit, which is determined by the nature of work and salaries paid. The tax credit bridged the client’s expenses and added another four months of runway. It gave the frim the extra push it needed to make it to the second round of PPP, and the business survived the ordeal intact.  

Without this tax credit, this client would have been forced to choose between laying off five full-time employees or reducing the entire staff’s hours. Fortunately, the refund from the R&D tax credit allowed the company to maintain its entire team. As a result, not a single employee was laid off!

The firm is doing great today. They recently acquired their largest client yet, and – with their entire team intact – they’re in an excellent position to ride the recovery to a bright future, all thanks to the R&D tax credit. 

 Company 2: $3.4M SaaS Company with 50-60 employees

This client took losses for multiple years and, in the process, built up a hefty sum of net operating losses. These NOLs, which offset taxes in later years of profitability, were being carried forward year over year, and they allowed the company to “soak up” its tax bill for years once it became profitable. 

By the time 2020 came along, the company was performing well despite the global pandemic. In fact, ‘performed well’ might be an understatement. The company posted a 150% increase in sales while growing EBITDA five times. Those are huge numbers that most companies work toward for many years. The firm’s resurgence proved naysayers wrong and surpassed even the most optimistic expectations.

Unfortunately, these kinds of drastic changes also create new complications, particularly for startups with early loss years followed by NOLs that soaked up their first few years of profit. 

“Does a tax bill that falls in a forest with no one there to pay it still exist?” Unfortunately, for most top-line focused business operators – who likely have no concern for existentialism – the answer is still no. 

In 2020, this client “first” noticed line 35 of their 1120. Suddenly, the business went from paying zero taxes to having a gigantic tax bill totaling more than $100,000! 

And, the story got worse. Unfortunately, due to a technicality in the firm’s corporate bylaws and structure, its treasury requirements forced management to formally notify the board of directors via email about the out-of-budget expense, which was payable on April 15. 

How We Helped

Lucky for the client, we brought them into our Tax Credits & Incentives practice and identified a $123,000 R&D tax credit, which more than offset their 2020 income tax liability. Better yet, the credit exceeded the total tax liability, and the company was left with a $13,000 credit to carry forward to 2021 and use against next year’s taxes. 

It’s still surprising to us how many clients are “sleeping” on these dollar-for-dollar savings. But, on the bright side, most clients can maximize their benefit beyond the engagement year once they understand the nuances and mechanics behind the R&D tax credit. Clients who understand the power of these credits can plan for the future more effectively and even retroactively claim missed credits from previous years.

It was the same scenario with the client mentioned above. We were delighted to find missed credits on previous returns, and we amended the client’s 2018 and 2019 tax returns to get them even more credits. 

The business stockpiled these tax credits in the same way as the NOLs from prior years, and, thanks to our analysis, the client avoided most of their 2021 estimated tax liability. We also discovered qualifying activities performed back in previous years, such as software development and UX/UI research for crucial projects. As a result, we helped this client take advantage of $300,000 worth of tax credits over a three-year period with just one engagement. 

Many firms are quick to point out examples such as these, but the real credit goes to the client. In this case, the CEO and their controller/CFO invested their time and attention to understanding the nuances and mechanics of how the R&D tax credit works, and it paid off big. 

The R&D Tax Credit Can Help Your Business Too

The R&D tax credit is the most significant tax strategy that we cover with our clients. It often allows innovative companies to reap substantial rewards for the work they’re already doing. 

Unfortunately, many growth-focused businesses overlook this valuable tax credit. Usually, only companies with a dedicated Tax VP manager make use of these game-changing tax credits. 

The good news is, your business probably has similar opportunities to save cash or operate more efficiently from a tax perspective.

To get started, check out our R&D tax credit guide here and schedule a free viability assessment at the below link: