Accessing Working Capital Through Tax Credits

Christina Matheny: Good afternoon, everybody. How are we doing? Great. Did you hear the choir this morning? Everything was great. Well, thanks for joining us for a panel discussing tax credits. Today, we'll talk about how small and medium-size businesses can use tax credits to provide non-dilutive funding for their businesses.

I'm Christina Matheny. I'll be moderating the session. We have two panelists this afternoon. So first, let's introduce Monika Diehl. Do you mind introducing yourself?

Monika Diehl: Sure, no problem. I'm Monika Diehl. I head up the tax group at Claris R&D. We work on research and development tax credits. My background—I've been a CPA for a little over 20 years now. Started off in public accounting working with Big Four, and gone back and forth between industry and other regional firms since then.

Christina: Thank you, Monika. Chris, do you mind introducing yourself?

Chris Winslow: Yeah, sure. I'm Chris Winslow. So, I'm vice president and general manager of the group. But like many of you, I spent the majority of my career either founding, running or funding startup businesses, running small and medium-size businesses, some successfully, to be honest, some not so successfully. But I realized during that entire period how much the ability to find non-dilutive funding is to a business and when I became CEO of Claris before it was acquired by TriNet, I got an appreciation for the $250 million worth of credits that we were able to attain for our clients, what that meant to their business.

Christina:
So can you talk about what kind of credits are available to small and medium-size businesses, Chris?

Chris: Yeah, I look at them in two categories. So, if I look at discretionary credits, almost every municipality and state provides opportunities for local businesses to monetize either workforce, expansion and retention, or capital investment.

And we can help with some of the documentation, et cetera around that, but it's a very localized process, and I've done it before, and I encourage every small business and medium-size business to go look at those opportunities in their communities. There's also statutory credits at a federal level and there's some really interesting ones about that.

There's the Work Opportunity Tax Credit, which really focuses on those marginalized employees and your ability to go get a credit for bringing them on. There's the ERTC, which I'm sure everybody's familiar with. That came out during COVID to help businesses survive. And then one we'll spend most time on today is really around the research and development tax credit, which has been around for decades, very codified in the federal code and has created huge opportunities for companies that are innovating within the United States.

Christina: Yeah, so I can set the stage quickly for R&D tax credits. So, the R&D tax credit has been around since the ‘80s. Originally, it was created as an income tax credit, and as many startups and small businesses know that's a credit that maybe you aren't able to realize yet, right. You're spending more money than you're bringing in, so you don't have that liability.

And so in 2015, the PATH Act was passed and that signed the R&D tax credit into law. And so it no longer had to be voted on each year. And it also enabled the credit to be utilized against your payroll tax liability, which, obviously, if you have employees, that's something that you do have to pay.

And so, it made it a lot more accessible to small and medium-size businesses. One fact that's a little wild to me is the U.S. government allocates $90 billion towards this tax credit every year and only about one-third of that is actually claimed. So there's a lot still out there on the table for small, medium-size businesses, and businesses of all sizes, to take advantage of the R&D tax credit.

So, let's just jump right in, Chris, who usually qualifies for the R&D tax credit?

Chris: Well, the tax credits, as it's defined by the IRS, is around research and development, which is what you think about, which is the process of trial and error of creating something new, but it's a fairly broad application. It needs to be technical in nature, but technical can be fairly broad.

So, for instance, the classic ones are software development, new manufacturing processes, biotechnology, et cetera. But we also find, you know, chemical processes and, you know, formula processes are also key. So you could be a dog food manufacturer, you could be a microbrewery. And because of the fact that you go through a trial and error process to create your formula, you have some uncertainty in that process as you're going through it, allows you to then qualify for that under the R&D tax credit. And we've seen this broad range of clients use it to help fund their business, that this year, the average credit that the clients that we work with are getting is over $100,000 for this past tax year.

Christina: That's some serious money. So, it was signed into law in 2015, been around since the ‘80s. Monika, what are the new legislation changes for the R&D tax credit?

Monika: Yeah, so the most recent change would be the Inflation Reduction Act actually impacted the R&D credit as it relates to early-stage companies. So the credit you were describing that was passed with the PATH Act allowed early-stage companies to be able to take the credit against their payroll taxes.

And so what happened was, as it was originally written into the PATH Act, that credit was capped at $250,000 per tax year and it was eligible to be used against the employer's portion of Social Security tax. Now, with the Inflation Reduction Act, for tax years beginning after December 31st, 2022, businesses can take a credit of up to $500,000, so they doubled that cap. And businesses starting with 941s, those payroll tax returns filed in 2023, are eligible to use those credits against both the employer's portion of Social Security tax and also Medicare tax. And so this change kind of doubled the value of the credit and it also gave businesses the ability to use those credits more quickly.

Christina: So, we've heard a lot about 174, Section 174, and how it might have an impact on claiming the R&D tax credit. Can you explain what Section 174 is to the folks in the room?

Monika: Yeah. So, Section 174 is the part of the tax code that basically says when a business is allowed to deduct their spend related to research and experimentation for a year on their tax return.

It has always been available to either, the taxpayer had a couple of options, they could either fully deduct those expenses in the year that they were paid or they could amortize those costs over five years. Now there's a change in 174, which is what everybody's been talking about. That change actually happened with the Tax Cuts and Jobs Act back in 2017.

And the change that went into effect starting in 2022, or tax years ending after December 31st, 2021, took away the ability for businesses to deduct those expenses currently. So that increased taxable income and increased tax liabilities for a lot of businesses. So that was what kind of that change was.

Christina: And so how does it affect applying the credit? Does it affect it?

Monika: Yeah, so the effect that I've seen is that it's just created a lot of confusion, a lot of confusion around what does 174 mean related to the R&D tax credit. What happened is, you know, that change impacted the way that those expenses are deducted in the tax return.

It didn't really impact the R&D tax credit. It didn't impact how it's calculated, how it can be utilized in the tax return. There's just been a lot of confusion. We have clients telling us, "this changed the value of the R&D credit, it's not worth as much,” or “I'm not even eligible to take the R&D credit anymore."

And the fact is that the credit is still there, businesses are still eligible to use the credit like they always have been, you just want to work with a tax professional who can help you navigate different strategies around this and also other things in calculating your R&D credit.

Christina: Monika, I have another question for you. Chris, I'll get to you in just a minute, I promise. So many people in this audience are either PEO clients or potentially looking to be PEO clients. And so, when we're thinking about tax credits and maybe specifically the R&D tax credits, is there a change in how a company can claim these tax credits under a PEO agreement? Does that change anything for them?

Monika: Yeah, so it's a little bit different. If you're looking at a business that works with a traditional payroll provider, they're going to have their R&D credit calculated by either their CPA or another provider. That credit information is submitted to their payroll tax provider, and the payroll provider will then apply that credit on their quarterly payroll tax return.

And businesses are eligible to start using that credit in the first quarter after the quarter in which the business income tax return is filed. So just a little bit of, you know, kind of tracking the time there. And the way that this is different with the PEO is that the business will submit their credit information to the PEO and the PEO then includes that credit on their 941s, but their 941 is a combined 941. It includes a group of clients together. And what ends up happening is that businesses typically have paid in all the payroll tax that they need to pay each time they do payroll. And so what ends up happening is that when they apply that credit, they're overpaid and then they have a refund coming back from the IRS, either directly in the situation where they're working with a direct, traditional kind of payroll provider, or through their PEO, where it's filed on a PEO return.

Christina: Sounds a little complicated.

Monika: A little bit.

Christina: So how does TriNet assist with the process?

Monika: Yeah, so the way that TriNet is working with clients on their R&D tax credits is that the clients are submitting their credit information to TriNet and actually that credit information, as well as some supporting documentation, are submitted together. That information comes over to Claris and we do a review of the information that they've submitted. And what we're looking for is just the basic requirements to claim an R&D credit the IRS would be looking for. We just make sure that all those points are there. Do a quick review. Once our review is complete, we forward that information on to the payroll tax team, and then they go ahead and start processing those credits.

Christina: So, you're validating the credits that come in. Okay, that makes sense. So Chris, what has TriNet done to support their clients through the process?

Chris: Yeah. So for any of you that were at the keynote this morning with Burton, he talked a little bit about this already. You know, part of the philosophy is how can we help small and medium-size businesses run better, get access to more resources, basically put them in a position to be more successful. And so part of the vision was, let's find a partner that we can bring into the fold inside of TriNet that actually streamlines this somewhat complex process that Monika just described in a way that makes it much easier for TriNet PEO clients and for their HCM SaaS clients to be able to access those credits.

And so a little over a year ago, TriNet acquired Claris. And Claris, over the last seven years, has built a process that's both technology-based that allows for a much more streamlined way for clients to interact with the somewhat complex IRS code to get the credit qualified, as well as a team of tax professionals that can help quality assure that and then do the filing, as Monika talked about.

So as of now, the merger, we have a fairly integrated process now for streamlining access to that credit, for filing, for making sure that it's quality assured. And frankly, part of, you know, our value proposition is providing representation in case the IRS would like to see some more validation for how that credit was calculated and how it was filed.

Christina: So the acquisition happened about a year ago, almost exactly. So does the combination of Claris R&D and TriNet provide unique opportunities for TriNet clients, especially as they're thinking about PEOs in general? How is TriNet differentiating themselves there?

Chris: Yeah, absolutely. So, one of the big steps that was taken after the acquisition was look at, okay, so I can provide a better process for this, but how do I actually get capital in the hands of these clients faster? And as Monika pointed out, you know, in the PEO environment where you're aggregating those filings together, it does create a certain level of complexity and also a delay in many cases of timing in which that refunded credit can get back to the individual company.

And so, we took on a process where essentially we're providing installments against a qualified credit. So, once we validated the credit through our process, whether it went through our technology or frankly, whether it went through a third party that the clients may have chosen to use, once we validated that, we can put them into a process in which we can provide installments against that credit ahead of when they would actually get it as a refund. That allows us to put capital in the pockets of clients much faster than what you could normally do in a PEO environment. And frankly, TriNet then takes the burden on of that delay.

And so it's been really popular in this past tax year, since we've implemented it. We've got tens of millions of dollars that were put out through its process this year. And we're really excited about this next coming tax year, given the expansion in the size of the credit that's now available to those taking it against payroll, as Monika talked about going to $500,000 starting, you know, for the 2022 or 2023 tax year.

So, filing for next year against this past year's taxes and being able to implement that accelerated process is part of it. We really feel like we had a huge amount of opportunity for clients.

Christina: So you just talked about the accelerated process and earlier, Monika mentioned kind of the complications and how complicated it is to go through the PEO process and how we're simplifying that, right? So the month after filing your taxes sounds pretty quick, considering how complex that could be. How long does it usually take to access R&D tax credits in a PEO environment?

Chris: Usually, we're seeing six to nine months, typically, from a refund perspective. And through this process, once we've validated everything, we can start providing those installments within the next two months. So, it really accelerates that access to the credit.

Christina: Sounds incredible. So I heard a lot of exciting things today. We have non-dilutive funding, obviously, is a great way for small and medium-size businesses to generate cash flow without diluting their ownership. We hear that all the time for R&D tax credit.

Clearly, there's a lot of opportunities for small and medium-size businesses to get access to capital through tax credits. We strongly encourage you to explore your federal, local and state opportunities. There might be some time limitations as well as revenue limitations. So, just make sure you're not letting these opportunities kind of go by.

As a part of the TriNet community, we're continually working on ways to get you access to credits that provide non-dilutive capital and we'll continue to do so for small and medium-size businesses. So I wanted to leave room for questions that we can help answer to anyone in the audience.

Go ahead, sir.

Audience member #1: So are there any revenue limitations for the R&D tax credit?

Christina: That's a great question. So what he asked is, are there any revenue limitations to taking the R&D tax credit? And then does it taper off or how do we handle look back years?

Monika: Yeah, that is a good question. So where the limitations are is related to the payroll benefit. So the payroll credit is available to early-stage companies. It was really designed for startup companies that don't have any taxable income in their early years.

They're doing the type of work that the credit was designed to encourage. They're creating new products and innovating. But there was a credit out there that really wasn't valuable to them because they couldn't monetize it. So, in order to really target that group, the payroll credit is available to a qualifying small business, which is a business that's within their first five years of having any gross receipts at all, even interest, and they have less than five million in gross receipts in their credit year.

And the other limitation is that the credit is eligible to be made that way. The election to take the credit against payroll taxes can be made only five times. And so there is, like I said, this is really kind of focused on those early-stage companies. Now, when you're looking at an income tax credit, any business can take that credit.

Any business can take that credit every year that they have R&D activity and R&D spend. They can take that credit, there's no limitation on how much money they make. There's no limitation. There's no cap on the amount of the credit. So that's an important point to think of as, you know, these earlier companies graduate into that income tax credit.

Chris: Yeah, maybe just to follow up on that, there's a 20-year carry forward on the utilization of that credit. So what we see is a lot of people that graduate from the payroll credit to the income credit, even sometimes before they're generating significant income because they can use that as a tax loss carry forward.

So we see that a lot in biotech. We see it a lot in other technology companies where they're accumulating losses, they get to use it against payroll during that first five-year period. But then, you know, they're fully expecting to get FDA approval. They're fully expecting to have a big move into the marketplace coming up in the next few years.

So accumulating those tax losses and then applying the R&D tax credit to that, that can accumulate and then you can use it over the next 20 years, has a huge advantage to those companies once they start generating real income. So that's a really good qualifying question.

Audience member #1: Can I just clarify? You said they could use that R&D tax credit for 20 years?

Chris: Correct. So let's suppose you took a half a million dollar credit. Next year, you know, you only made $100,000. You could take it against that $100,000. You still have $400,000 left. So the year after that, if you made $200,000, you could take $200,000 against it. So, you guys separate the difference between qualifying in the year, but then how you actually use the credit then going forward, you have a lot of flexibility over the next 20 years to be able to apply that against that income credit.

Audience member #2: Is this typically something you're seeing CPAs identify? I just emailed mine while we were sitting here. And just maybe speak to the value of using Claris versus just going to your CPA and saying, "Hey, do we get this?"

Chris: Yeah, maybe I'll take that one. So what we've found, and actually this is part of why Claris was developed. Monika's CPA, she's got a whole team of CPAs. A lot of them came out of big four, big regional firms, etcetera. What we tend to find is that, yes, CPAs should know about it and many CPAs do. The challenge that CPAs have is it's a relatively complex qualification process, meaning what the IRS rules state is you have to demonstrate that you qualify for this credit. And that means, you have to go in and say, "Okay, this is actually the R&D process that I do. I have trial and error. This is the technology I use. You know, this is the experimentation I do," and document that. Then you say, "Okay, what are my actual expenses against that?” That's labor. That's materials. It's other resources. And then it can only be done with U.S. workers. It can't be done overseas. You have to own the IP.

So there's these number of qualifications that the IRS define in order to make it work. For a lot of CPAs, frankly, it's not worth that much work for what they would tend to do in your study. And so, what we tend to find is, they're qualified to do it. And, as a client, you can use your CPA and we'll help you validate that study.

On the other hand, what we have also found in doing this, that many CPAs do not fully recognize all the expenses and the capabilities that you could use toward that credit, because frankly, it's a lot of work to get to all the pieces. We built this software that really makes it easy for clients to go through the process and go through the qualification.

And then with our team of experts, they'll go in and qualify each one of those and then come back and say, "You know what? I think you've left some on the table here. I think if you do this, you can actually get some more credit." So we've actually seen, you know, in this last year that we've been doing this business, a pretty distinct differential between those clients that had done it previously and submitted it and those clients that did it through us in terms of the amount of actual eligible credit that they're able to get back because of the thoroughness of the process.

But like I said, you know, a lot of people are comfortable with their CPA and we have a process where we can help validate that study too as it comes through TriNet for qualification, but many clients have found that it's beneficial to run through the Claris process as part of this.

Christina : Do you want to piggyback off of that question, talk a little bit about partnerships that we have within CPA groups?

Chris: Yeah, this is good. So we have over 250 CPA partners, so we don't really see it as a competitive environment. Many of the CPAs, because of that complexity I talked about, are looking for a tool set that they can work with. And so many of them will work through us, to actually go generate those credits on behalf of their clients. And so, we find it to be a really good symbiotic relationship with those other tax professionals as well.

Audience member #3: Do you need to be a PEO client to take advantage of Claris??

Chris: Absolutely not. So, the previous benefits, SaaS, HGM clients absolutely can use Claris. And it'll help streamline not only the qualification and calculation part, but also the filing part.

Audience member #4: When you identify the opportunity, are you typically going to previous tax years? You know, let's say this was something that was missed. Are you going back? And then the follow on to that, it takes an opinion is, do you create audit risk? You know, we don't want red flags for our friends.

Monika: Yep. Always get that question. So where does the audit risk come in? The truth is the IRS doesn't tell us how they pick people for audit, probably for good reason. But, we have not seen where a company goes back and amends their tax return to claim an R&D credit that they're automatically audited.

You know, we're not seeing that. The important point is doing the work correctly, doing the documentation, making sure you understand the rules and you're claiming eligible activities and eligible expenses. Businesses do have the ability to go back three years. That's the statute of limitations on your tax return and amend your tax return to claim a credit.

Not necessarily a trigger for an audit. The one thing to think about when you do go back and amend tax returns is the payroll election is not available. So if you're an early-stage company that was eligible for the payroll credit, you do need to take that currently on an originally filed return. You cannot go back and amend and make that election.

You would still be able to take an income tax credit. You still have that 20-year carryover period that Chris mentioned. So it is something that could still be valuable to you in the future, but you wouldn't have that kind of immediate benefit of the payroll credit.

**Audience member #: 5 **Just on the writing code. I'm writing code. I'm innovating every year. I've got a plan for five years. Is that correct?

Christina: So his question is around, he has a team that writes code, he writes code and so at what point is he not able to take a credit anymore? I won't take this, but would one of you like to?

Chris: Sure. So writing code, if you're doing research and development, meaning you're trying to develop a new product, a new solution, innovating on an existing solution, then, you know, the cost associated with that, which would be labor, could be your AWS account. There are expenses that are allowable for that. All of that in that year is eligible for the credit. So the limitation on the payroll is really, you know, you have to be less than $5 million in revenue and you have to have had any revenue at all for no more than five years, and you can only take it five times, so that's how you qualify again.

How you use it has up to 20 years to actually apply it to whatever you have, right? So you’ve got to separate the two issues qualifying every year. You're developing new code every year, you could qualify for another credit. When you got to year six, you could still do it. It's just that you would typically use that credit then against your income, you know, whatever earnings you had as a company because it would no longer be applicable against your payroll taxes.

Christina: That's a great question.

Do we have any other questions out here? All right. Well, thank you so much. It was really lovely to have an afternoon with you all and we hope you enjoy the rest of PeopleForce. But thanks for joining our session on tax credits.

Monika: Thank you.