Grants or Startup Tax Credit: Which one is right for you?

Grants or Startup Tax Credit: Which one is right for you? Webinar September 19 th, 2018 Jacob Setterbo, Ph.D., Director of Grants Jim Foster, J.D., National Tax Director

Presentation Overview Overview of Grants Compare: Grants vs. R&D Tax Credits Overview of R&D Tax Credit Details on Startup R&D Tax Credit Q&A

Example Taxable Income vs. Time

Why Grants? Grants

Why Grants? Top 4 Reasons: 1. Not a loan no repayment 2. Non-dilutive no equity forfeiture 3. No intellectual property (IP) forfeiture 4. Provides recognition, verification, and visibility

Which Grants? 10s to 100s depending on your topic Choose your battles wisely Tenured Professor Entrepreneur

Which Grants? #1 Professors/ Universities Funds research and development (R&D) that has the potential for commercialization! Small Businesses

SBIR/STTR Participating Agencies Agencies 1. Department of Agriculture 2. Department of Commerce National Institute of Standards and Technology National Oceanic and Atmospheric Administration 3. Department of Defense 4. Department of Education 5. Department of Energy 6. Department of Health and Human Services National Institutes of Health 7. Department of Homeland Security 8. Department of Transportation 9. Environmental Protection Agency 10. National Aeronautics and Space Administration Figure: SBIR/STTR Budgets by Agency (FY13) - ~$2.3B Total 11. National Science Foundation

SBIR/STTR Eligibility For profit, located in US <500 employees Ownership: >50% by U.S. individuals National Institutes of Health (NIH) SBIRs allow: >50% owned by multiple VC firms, etc.

SBIR/STTR Eligibility Facilities/Team SBIR *67% through small business Principal Investigator (PI) employed 50% at small business STTR (partnership) 40% through small business Requires 30% through single university/institution NIH allows PI to be employed at the university *NIH allows as low as 50% through small business

SBIR/STTR Review Process & Success Rates (NIH) Most reviewers are professors NIH SBIR/STTR: 15-20% get funded

SBIR/STTR Review Process & Success Rates (NIH) Application score is based on 5 criteria: 1. Significance (importance/impact) 2. Investigators (PhDs/MDs/patents/experience) 3. Innovation (differentiation/new-to-world) 4. Approach (logical/backed by science) 5. Environment (company & collab. facilities) Before applying: Is your Project/Team among the best?

SBIR/STTR Award Information Phases Phase I: feasibility Phase II: continuation Fast Track: Phase I & II (Phase III: on your own) Phase I $150K - $225K 1 year Phase II $1M - $1.5M 2 years Phase III Fast Track

SBIR/STTR Timeline to Funding April 5 th Deadline (NIH) EXAMPLE 1 First Submission ~6-8 months from submission to award Submit 2 mos. Scientific Review 3-4 mos. Advisory Council 2-4 mos. Begin R&D PROJECT Phase I 12 mos. Jan 2 3 4 5 6 7 8 9 10 11 12 Jan 2 3 4 5 6 7 8 9 10 11 12

SBIR/STTR Timeline to Funding April 5 th Deadline (NIH) EXAMPLE 2 Resubmission ~12-14 months from submission to award Submit 2 mos. Scientific Review 3-4 mos. Submit 2 mos. Scientific Review 3-4 mos. Advisory Council 2-4 mos. Begin R&D Project Phase I 12 mos. Jan 2 3 4 5 6 7 8 9 10 11 12 Jan 2 3 4 5 6 7 8 9 10 11 12 Jan 2 3 4

Why R&D Tax Credits? R&D Tax Credits (2015) R&D Tax Credits (2016+) Grants TAKE-AWAY: You no longer need taxable income!

Why R&D Tax Credits? Top 3 Reasons: 1. Not a loan no repayment 2. Non-dilutive no equity forfeiture 3. No intellectual property (IP) forfeiture 4. Provides recognition, verification, and visibility

R&D Tax Credits Eligibility & Success Rates Eligibility determined by: Gross Receipts Qualifying Research Expenditures (QREs) Unlike SBIR/STTR projects, your R&D projects could be: From any technology sector Boring / incremental Success Rates: Near 100% IF you follow IRS rules!

R&D Tax Credits Timeline to Funding March 15 th Deadline EXAMPLE 1 Standard R&D Tax Credit [companies with taxable income] Qualifying R&D EXPENSES 12 mos. File Taxes Credit provides immediate savings. Jan 2 3 4 5 6 7 8 9 10 11 12 Jan 2 3 4 5 6 7 8 9 10 11 12 2017 2018

R&D Tax Credits Timeline to Funding March 15 th Deadline EXAMPLE 2 Payroll (Startup) R&D Tax Credit [no taxable income required] Qualifying R&D EXPENSES 12 mos. File Taxes Credit Offsets Payroll Taxes Offset begins the quarter after filing Jan 2 3 4 5 6 7 8 9 10 11 12 Jan 2 3 4 5 6 7 8 9 10 11 12 2017 2018 2019 Jan 2 3 4

GRANTS vs. R&D Tax Credits Grants R&D Tax Credits Success Rate 15-20% (judged by professors) Near 100% (judged by IRS rules) Forward or Backward-Looking? Timeline to Money/Credit Amount Forward: Future projects 6-10 months from time of submission $225K for Phase I $1.5M for Phase II Backward: Past projects 0-3 months from time of filing 8-12% of Qualifying R&D You should do both if possible!

Presentation Overview Overview of Grants Compare: Grants vs. R&D Tax Credits Overview of R&D Tax Credit Details on Startup R&D Tax Credit Q&A

What is the R&D Tax Credit? GOAL: Keep innovation and creativity in the U.S. Encourage economic growth BENEFIT: Tax credit for companies that perform R&D in the U.S.

History of the R&D Tax Credit TIMELINE: First adoption of R&D tax credit (The Economic Recovery Tax Act of 1981) 3 HISTORIC CHANGES! [Protecting Americans from Tax Hikes (PATH) Act of 2015] Several expirations of credit, then retroactive extensions 1980-1985 - 1990-1995 - 2000-2005 - 2010-2015 - Small to mid-size companies made eligible to take the R&D (wage-based) tax credits

History of the R&D Tax Credit PATH Act of 2015 1. Made R&D Tax Credit PERMANENT for the first time 2. Small Businesses can claim the credit against the Alternative Minimum Tax (AMT) 3. Startups can claim up to $250K of the credit against the company's payroll tax 3 HISTORIC CHANGES! [Protecting Americans from Tax Hikes (PATH) Act of 2015] 1980-1985 - 1990-1995 - 2000-2005 - 2010-2015 -

1) R&D Tax Credit is now PERMANENT Businesses can now budget for tax credits in confidence Credit will not expire in the middle of the fiscal year

2) Small Businesses can claim the credit against AMT 2015 Alternative Minimum Tax OVERVIEW RTL=Regular Tax Liability TMT=Tentative Minimum Tax AMT=Alternative Minimum Tax R&D Tax Credit Credit can offset the spread (spread = RTL-TMT) TMT Scenario 1: TMT>RTL AMT RTL Scenario 2: TMT<RTL RTL R&D credit

2) Small Businesses can claim the credit against AMT 2016 (PATH Act Changes) Alternative Minimum Tax OVERVIEW RTL=Regular Tax Liability TMT=Tentative Minimum Tax (Set to $0 for credit utilization) AMT=Alternative Minimum Tax R&D Tax Credit Eligibility: Average annual gross receipts must be < $50M Credit can offset any taxes paid! TMT R&D credit Scenario 1: TMT>RTL AMT RTL Scenario 2: TMT<RTL RTL R&D credit

2) Small Businesses can claim the credit against AMT CHANGES explained using TI vs. Time Graph

2) Small Businesses can claim the credit against AMT 2015/old

2) Small Businesses can claim the credit against AMT 2016/new

3) Startups can claim the credit against payroll tax 2016/new

3) Startups can claim the credit against payroll tax PATH Act of 2015 [no taxable income required!] For the 1 st time, R&D tax credit can offset payroll taxes Eligibility (more restrictions than AMT offset): Current year (e.g., 2017) gross receipts must be < $5M No gross receipts before 5-taxable-year period ending with current year (e.g., no GRs prior to 2013) Benefits Can offset payroll taxes quarterly after filing a return Benefit capped at $250K/year per company

3) Startups can claim the credit against payroll tax FORM 6765

3) Startups can claim the credit against payroll tax FORM 941 FORM 8974

What qualifies as R&D? Traditional Definition Tax Definition ( 4-Part Test ) 1. New or Improved Business Component Product Process Software (Internal or External) Technique Formula Invention 2. Technical Uncertainty 3. Process of Experimentation 4. Technological in Nature

Qualified R&D Expenses (QREs) If your project passes the 4-Part Test, you can qualify Three Expense Categories: 1. Wages 2. Supplies 3. 65% of Contract Research

Qualified R&D Expenses (QREs) Three Expense Categories: 1. Wages Includes: Form W-2 Partnership Earnings subject to Self Employment Tax Schedule C Bonuses paid to employees Excludes: 401(k) & fringe benefits

Qualified R&D Expenses (QREs) Three Expense Categories: 2. Supplies Items intended for use in R&D process Any tangible property used in the conduct of qualified research other than: land, improvements to land, or property subject to depreciation E.g.: lab animals, reagents, drugs, supply costs for prototypes, etc.

Qualified R&D Expenses (QREs) Three Expense Categories: 3. 65% of Contract Research Can include fees paid to: Non-employees Outside consultants/engineers/software developers Contract Research Organizations (CROs) Qualification depends on the contract (e.g., applicant must bear economic risk & retain substantial rights)

Tax Credit Amount Benefit varies by calculation method used Tax Credit = 8-12% of QREs: 10% with Regular Credit Method 8-12% with Simplified Credit Method

Other R&D Considerations Carryforward of credit R&D Tax Credits 20 years Payroll (Startup) Tax Credit indefinitely Net Operating Losses (NOLs) 20 years This may offset the need for R&D tax credit NOL

Startup Examples Life science examples (over-simplified): Company qualified? What proportion is QREs? Approximate credit?

Example 1 Preclinical Stage (All R&D, All the Time) Founded: 2013 Payroll and supplies: $242K + $8K Gross receipts: None All payroll ($242K) qualified: CEO: leads the R&D experiments Laboratory technicians assist with experiments Supplies ($8K) are qualified: Mice, rats, laboratory consumables, etc. FICA taxes (currently 6.2%) = $15,004 R&D credit estimate (using 10%) = $25,000

Example 2 Digital Health (R&D but Faster-Moving) Founded: 2014 Payroll: $1M Gross receipts: $500K in 2015 from app sales $5.5M in 2016 $4.2M in 2017 Only 75% ($750K) of payroll qualified: Most of the programmers are actively working on R&D But: CEO time fundraising and marketing is not qualified Administrative assistant also does not assist with R&D FICA taxes (currently 6.2%) = $62,000 R&D credit estimate (using 10%): $75,000

Example 3 Clinical (R&D and Approaching Commercialization) Founded: 2009 Payroll: $1M Outsourced/contract costs: $500K Gross receipts: None Only 70% ($700K) of payroll qualified R&D for 1 st and 2 nd pipeline drugs qualifies Sales and business development payroll does not qualify Only 50% ($250K) of contract costs is R&D, and only 65% of that qualifies ($162.5K): Hourly contractors performing R&D qualify Lawyer and consultant costs for IP and regulatory does not qualify FICA taxes (currently 6.2%) = $62,000 R&D credit estimate (using 10%) = $70,000 + $16,250 = $86,250

Example 3-b Clinical (R&D and Approaching Commercialization) Founded: 2009 Payroll: $1M Outsourced/contract costs: $500K Gross receipts: $150K in 2010 $0 in 2011-2016 COMPANY NOT QUALIFIED

Example 4 SBIR-Heavy (Some Payroll is Federally Funded) Founded: 2015 Payroll: $500K Only 60% ($300K) of payroll qualified: 100% of company s payroll is committed to R&D But: 40% of payroll ($200K) is funded by SBIR and is not qualified: Projects funded by grants are not allowed (per IRC 41(d)(4)(H)) FICA taxes (currently 6.2%) = $31,000 R&D credit estimate (using 10%): $30,000

HIREtech Overview Corporate Headquarters in Houston, Texas International Offices in Sydney, Australia and Toronto, Canada. (Grants)

HIREtech Overview Experts in Technical Tax Incentives We help CPAs and their clients recover millions in R&D Tax Credits. Similar to medicine, CPA firms refer clients to us because we are R&D Tax Credit specialists.

HIREtech Overview Experts in Technical Tax Incentives Our legal, technical (engineering) and tax knowledge of IRS Section 41 results in higher tax credits. Our staff includes experienced: IP Attorneys, R&D Engineers, Ph.D. Scientists, and IRS Audit Experts from national tax consulting firms.

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QUESTIONS? RESOURCES Internal Revenue Code section 41 (IRC 41) PATH Act Bill, Division Q, Part 3, Section 121 HIREtech 200 Westlake Park Blvd. Suite 501 Houston, TX 77079 281-558-7100 info@hiretech.com www.hiretech.com Jacob: ext. 151, jsetterbo@hiretech.com Jim: ext. 112, jfoster@hiretech.com