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The Smarter Startup

ERC and R&D Tax Credits for the 2021 Tax Year

ERC and R&D credits provide valuable tax savings to many startups. Can a company use the same wages to claim both in the 2021 tax year?

Summary:

  • R&D tax credits incentivize innovation with up to $250,000 in annual tax savings.
  • The ERC provides up to $21,000 in credit values per employee in 2021.
  • Companies cannot use the same wages to claim both credits for the 2021 tax year.

The R&D Tax Credit offers a compelling incentive for startups to invest in innovation, while the ERC (Employee Retention Credit) has been a lifeline for many companies during the pandemic. But what is the interplay between the two? Can a startup use the same wages for both ERC and R&D credits?

This article provides an overview of these two tax credits and related guidance for the 2021 tax year.

About the R&D Tax Credit

The Credit For Increasing Research Activities (R&D Tax Credit) has been part of the U.S. tax code since 1981. It was initially introduced in the Economic Recovery Tax Act of 1981 and made permanent in 2015.

The reason for the R&D Tax Credit is simple. The U.S. wants to retain leadership in technology and innovation. Innovation requires research and development, which is financially risky by nature. The R&D Tax Credit helps reduce the financial risks involved in innovation, especially for startups.

The R&D Tax Credit helps reduce the financial risks involved in innovation, especially for startups

If your startup qualifies for R&D tax credits, you may be able to deduct up to $250,000 per year in research and development expenses from your payroll tax or income tax. Learn more about which activities qualify for R&D credits and calculate your potential savings. Burkland tax clients saved over $10MM with these credits in the past year alone.

About the Employee Retention Credit

The Employee Retention Credit (ERC) is a refundable payroll tax credit for wages and health plan expenses. This tax credit was introduced under the CARES Act in 2020 and extended through Q3 2021. It applies to employers who saw their operations suspended or revenue significantly reduced due to COVID-19. The ERC provides qualified businesses with a quarterly tax credit up to $7,000 per employee in the first three quarters of 2021 or up to $21,000 per employee for the year.

The ERC provides qualified businesses with a quarterly tax credit up to $7,000 per employee in the first three quarters of 2021

Can My Startup Use the Same Wages to Claim ERC and R&D Tax Credits?

Unfortunately, no. The Consolidated Appropriations Act (CAA), which went into effect on December 27, 2020, and accompanying notices thereafter, state that a company cannot use the same wages to claim both the ERC and R&D credits for 2021. This is a change from tax year 2020, when many companies were able to claim both credits from the same wages.

A company cannot use the same wages to claim both the ERC and R&D credits for 2021

Startups that qualify for both credits in the 2021 tax year will need to carefully consider how they apply ERC credits to maximize their R&D credits and overall tax savings benefits. As a simple example, one smart move may be to start by applying ERC credits to the expenses and wages of employees who are not involved in R&D.

The U.S. tax code has never been simple, and the complexity has only increased in the wake of COVID-19 and related stimulus measures. Now more than ever, startups should seek qualified tax expertise to maximize their benefits without risking non-compliance related to credits and other common tax mistakes. Burkland’s tax experts help hundreds of startups every year file their taxes correctly while claiming millions of dollars in benefits.