Understanding the R&D Tax Credit for NOL Companies

The federal R&D tax credit is designed to incentivize companies engaged in qualified research activities. For early-stage companies without taxable income, the credit can be used to offset payroll taxes instead of income tax liability. However, this benefit isn’t immediate due to two key timing factors:

1. Filing Delays: Most companies extend their corporate tax return and won’t file until October 15th.
2. Payroll Tax Offset Delays: It can take up to two quarters after filing for the payroll provider to start applying the credit against payroll taxes.

The combined impact of these delays can create a serious cash flow gap for early-stage companies, particularly if they’re running low on funds.

Example: How Filing Extensions and Delays Impact Cash Flow

Let’s say a SaaS startup has the following financial profile:

• Annual payroll: $1M
• Net operating loss: $1.5M
• R&D tax credit: $100K

The company files for a six-month extension and submits its Form 1120 and Form 6765 in mid-October to claim the $100K R&D credit to offset payroll taxes.

Here’s the timeline:

• October 15th: Corporate tax return filed.
• November/December: Payroll provider begins processing the credit.
• January (at the earliest): Payroll taxes start being offset.

This means the company goes an additional 9-12 months after the year-end without seeing any payroll tax savings from the R&D credit. If they’re already low on cash, they may have halted payroll or laid off staff long before the credit takes effect.

Why Timing Matters for Cash Flow

The critical issue is that the R&D tax credit only offsets payroll taxes when there’s active payroll to offset. If the company runs out of cash and stops running payroll before the credit takes effect, the benefit is lost.

This can be a major blind spot for finance executives and founders counting on the credit to help manage cash burn.

What Can Founders Do to Manage This Risk?

1. File Early When Possible: Avoid extending your corporate tax return if cash flow is a concern. Filing earlier can accelerate the timing of the payroll tax offset.
2. Plan for Delays: Work with your CPA to map out when the credit will realistically start to apply and manage cash flow accordingly.
3. Secure Bridge Financing: Explore options like bridge loans or lines of credit to cover payroll costs while waiting for the credit to kick in.
4. Use Experienced Payroll Providers: Not all payroll companies are familiar with handling R&D credits efficiently. Choose a provider that knows the process and can reduce delays.

Conclusion

While the R&D tax credit is a valuable incentive, early-stage companies must understand the timing challenges when using it to offset payroll taxes. Filing delays, payroll provider processing times, and cash flow gaps can make the credit less effective when you need it most. Proactive planning and managing cash flow expectations are key to ensuring your company can fully benefit from the credit.

Founders and finance leaders need to ask themselves a critical question:
Will we still have active payroll to offset when the credit finally applies?