When it comes to modern entrepreneurship, startup businesses often serve as an example of innovation and economic growth. Governments and regulatory bodies have long recognized the pivotal role played by startups in fostering economic development, in addition to the financial challenges that accompany them. Through tax credits and incentives, these entities offer startups not only a lifeline, but also an environment where innovation can thrive.
There are many opportunities for startup businesses to increase cash flow and receive offsets for planned activities or activities that have already been completed. These opportunities are presented at both the Federal and State levels for businesses that have started within the past three years and are planning to grow.
Employee Retention Credits (ERC) for Recovery Startup Businesses
As the IRS continues to issue warnings about aggressive Employee Retention Credit (ERC) claims, there is one area of legitimate qualification that is sometimes underutilized: Recovery Startup Businesses. With IRS Notice 2021-49, the new category of eligible employers called ‘Recovery Startup Businesses’ (RSBs) came into the picture. Since newer businesses (i.e., startups) were finding that they could not qualify under the gross receipts or shutdown rules (due to being unable to compare 2020 and 2021 data to prior years, as they had not conducted business before 2020), Congress passed legislation to reward RSBs for hiring new employees while starting a business during the unprecedented economic uncertainty that COVID-19 brought.
As a refresher, the ERC is a refund of payroll taxes previously paid by a business, including not-for-profit organizations. Assuming a business qualifies for the ERC, the business can receive this payroll tax refund by filing amended payroll tax returns for the qualifying quarters. Startups have a unique, and far less cumbersome, set of hoops to clear in order to qualify for the ERC.
The main requirements are:
- The business must have started on or after February 15, 2020. The determination of when an employer “began carrying on a trade or business” is made in the same manner as for purposes of tax code Section 162. Generally, a taxpayer has not begun carrying on a trade or business “until such time as the business has begun to function as a going concern and performed those activities for which it was organized.” (There is a bit of flexibility in establishing this date)
- The business must have less than $1 million in gross receipts for 2020 (assuming it was started in 2020).
- If the business is under common ownership with any other entities, the aggregation rules need to be applied for testing.
- If qualified, RSBs are limited to quarters 3 and 4 of 2021 for claiming the credit, and each quarter’s credit is capped at $50,000 each.
Beyond that, there are few other hurdles to overcome, since the usual requirements of proving a decline in gross receipts or the impact of the shutdown are completely removed for RSBs.
For example, let’s say a small business opened in May of 2020 with 10 employees, including the majority owner and his son. This majority owner does not have any ownership interests in other businesses. The gross receipts for May to December 2020 are $80,000, which translates to $120,000 on an annualized basis. Since these 2020 annualized receipts are less than $1,000,000, and there are no other business ownership interests to aggregate for testing, this new business would qualify as an RSB. As a result, a refundable credit of 70% of all wages (with the exception of those for the majority owner and his son), up to $10,000 per employee per quarter, is available for quarters 3 and 4 of 2021, with a maximum credit of $50,000 per quarter.
The ERC for RSBs must be claimed by April 15, 2025. For many startups, this potential refundable credit of up to $100,000 is certainly worth exploring. If qualification occurs, this credit aligns with the original Congressional intent to help keep the economy strong and assist new businesses with their payroll costs during and after the pandemic.
Startup Credits & Incentives
In addition to the ERC tax credits for RSBs, there are additional opportunities available startups if they have plans to hire or make an investment in property or machinery and equipment. Most states across the U.S. offer incentive programs to help entice a company to incorporate or move existing operations to increase the state’s tax base. These programs vary based on the types of activities they want to promote. Activities might include the creation of jobs, capital investment and training. Each incentive program depends on the type of activity, but all programs aim to encourage businesses to grow and expand.
When one hears the term “incentives”, they may think of well-known, multi-state and million-dollar projects as seen in the news; however, most of these programs are available to any business that is engaging in growth activities – even startups. The programs vary by state, but most states do have a minimum threshold that accounts for startups and small businesses.
Examples of these programs:
- Job creation tax credits, refundable or nonrefundable, can offset a company’s state income tax liability for a certain number of years based on the amount of full-time state residents they intend to hire over a period of time. If nonrefundable, there is usually a carry forward provision that allows an offset for a certain number of years if they do not realize the full value of the credit within a given year.
- Investment tax credits offset corporate income tax liability by a certain percentage of capital investments made once a project has been established. Requirements for these programs can vary; however, the most common is a commitment to job creation in addition to the investment. Eligible capital investment can include new machinery, modern manufacturing and building costs. This credit can be granted over the life of the project, which usually lasts up to five to ten years and requires annual reporting.
- Headquarters relocation tax credits are assessed against the state tax liability for moving corporate headquarters to a new state and usually includes certain revenue and job creation requirements. This program provides a tax credit for a percentage of the reimbursement expenses that took place during relocation. Some programs account for startups and small business by designating a “Small Headquarters Relocation Tax Credit”, which lowers the revenue and employment thresholds.
- Training programs are offered on many levels to employers of all sizes and can be offered in either in-kind services, cash reimbursement or upfront funding for training activities. States typically have a goal of increasing their minimum wage on an annual basis to increase their tax base, and the best way to do this would be to upskill the existing workforce. Specific dollars are usually allocated by each state annually, and the thresholds for qualification vary.
These are just a few programs that are offered to assist businesses in their efforts to grow and expand their operations. Some programs can be discretionary and negotiated, while others can be statutory, open to all who meet the requirements, depending on the state’s guidelines. In some cases, programs can be lumped together as one package offering from the state.
Site selection and incentives consultants can help estimate the value of the incentives offered by states across the U.S., as well as help negotiate incentives on the company’s behalf. Before making any decisions on hiring, expanding onto an existing location, relocating your business, or making a capital investment, consider speaking with Sikich’s tax and incentives consultants about your company’s specific situation.If you have questions or would like more information, please contact our authors, Abbey Titzer and Debbie Warden.
About our Authors
Abbey Titzer
Abbey Titzer is a manager of client services for site selection & business incentives at Sikich. Her experience includes consulting business leaders on site selection, incentive procurement and more.
Debbie Warden
Debbie Warden, CPA, is a tax director with more than 25 years of experience providing tax and accounting services to businesses and individuals with special attention to minimizing tax liabilities through tax planning, including tax credits and other incentives. Her background in both public accounting and industry gives her insight into the challenges faced by businesses and the strategies available to overcome them.
