The R&D Tax Aspects of Los Angeles Innovation
Los-Angeles-Innovation
The hottest industry in Los Angeles may no
longer be entertainment, as in recent years the city's tech
scene has emerged and grown at a rapid pace. Attracted
by the city's weather, nightlife, abundant transportation
choices, and quantity of talent, tech firms (both large and
small) are choosing L.A. as an operating base. From a tax
standpoint, the more time developing new products and
technical services, the greater the likelihood that companies
will qualify for both federal and California R&D tax
credits.
The R&D Tax Credit
Enacted in 1981, the Federal Research and
Development (R&D) Tax Credit allows a credit of up to 13
percent of eligible spending for new and improved products and
processes. Qualified research must meet the following four
criteria:
- New or improved products,
processes or software
- Technological in nature
- Elimination of uncertainty
- Process of experimentation
Eligible costs include employee wages, cost of supplies, cost
of testing, contract research expenses, and costs associated
with developing a patent. On December 19, 2014,
President Obama signed the bill extending the R&D Tax
Credit for the 2014 tax year.
Companies in a wide variety of industries may be eligible for
R&D tax credits. Such industries may include (but are not
limited to): manufacturing, software and information
technology, biotech, food processing, pharmaceutical, and
logistics.
Recent L.A. Tech
Trends
The tech industry in Los Angeles has
rapidly grown in recent years, as the area has seen a surge in
both the number of startups and tech financing deals. The
startup investor website AngelList current has over 6,000
startup member companies in the Los Angeles area and over
14,000 investors members looking to invest in these startups.
According to the venture capital database CB Insights, more
than $4.5 billion has been invested into L.A. tech companies
since 2009 across a variety of sectors, the largest of which
has been internet-based companies.
The number of investment deals for L.A.
tech firms has increased every year in recent history, with
more than 300 deals taking place in 2013.
Source: CBInsights.com
Los Angeles Now a
Major Tech Hub
Despite being relatively a new tech scene,
the Los Angeles area's strong growth has now made it a major
tech hub. In a recent study from Upfront Ventures, the Los
Angeles area has the third highest share of early-stage
startups in the country, and is currently the fastest growing.
Because of this recent growth, 9% of the Los Angeles work
force now works in high-tech. This 9% accounts for 17% of the
area's total wages, with L.A. high-tech workers earning 67%
more on average than those employed in other industries. Since
the end of the recession, numerous high tech industries
in the L.A. area have seen significant growth in employment.
L.A. Growth in
Employment: Select Tech Industries
Category
|
2009-2013
Growth
|
| Internet
Publishing, Broadcasting, Web Search |
27.0% |
| Pharmaceutical
& Medicine |
14.7% |
| Data Processing,
Hosting & Related |
8.4% |
| Computer Systems
Design & Related |
7.0% |
| Aerospace
Product & Parts |
5.8% |
Since 2012, more than 250 companies based in the Los Angeles
area have raised more than $1 million in funding, with some of
the most notable being Snapchat, The Honest Company, SpaceX
and TrueCar. The amount of activity in the region has caught
the attention of venture capitalists, entrepreneurs, and
job-seekers looking to reap the benefits of the Los Angeles
tech environment.
Contributing Factors
and Future Growth
The recent growth in the Los Angeles tech
scene can largely be attributed to the prolific
entrepreneurial spirit of its residents and abundance of local
talent available.
A
2014 study by the Kauffman Index of Entrepreneurial Activity
listed the Los Angeles-Long Beach-Santa Ana area as having the
second highest entrepreneurship rate in the country, with 490
entrepreneurs per 100,000 individuals. This is approximately
14% higher than the third highest amount (Miami), and 19% more
than that of the New York City area. The entrepreneurial
spirit that has long been prevalent within the Los Angeles
arts and service industries has now spread to its emerging
tech industries.
When it comes to the sustaining the recent trends experienced
within the Los Angeles tech scene, the area is ripe with
talent to fuel future growth. The L.A. metropolitan area has
the highest total amount of engineers of any U.S. metropolitan
area, with approximately 70,000.
Additionally, local colleges and specialized schools are
expected to be key factors in future growth. With highly
ranked engineering programs that include Harvey Mudd College,
Caltech, UCLA and USC, technical talent is available in the
Los Angeles area to fill and create future tech jobs.
In recent years, the Los Angeles Unified School District
(LAUSD) has seen a sharp increase in applications to the
district’s 150+ magnet programs, many of which are focused in
sciences and applied mathematics. Currently, over 50,000
students are enrolled in LAUSD public magnet schools, with
thousands more in specialized private schools throughout the
area.
Many of these schools provide an interactive and collaborative
learning environment, showing a shift from 20th century
textbook passive learning to research-driven, active learning
emphasized by 21st century educators. With these specialized
schools potentially serving as feeder schools to the
abovementioned colleges and universities, the quantity of
homegrown talent in technological fields will likely see a
significant increase in the next decade.
The Added California
Benefit
For over 20 years, companies in California
have taken advantage of the state's Research and Development
Credit, one of the most beneficial in the country. The
non-refundable credit is equal to 15% of the incremental
qualified research expenses incurred in the state over the
calculated base amount, plus 24% of the basic research
payments over the base amount paid to independent research
institutions and universities. Similar to the federal credit,
eligible costs include wages, supplies, testing expenses,
contractor research expenses, and patent related expenses.
Unused research credits may be carried forward indefinitely,
making it attractive to early stage companies that are not yet
profitable.
Qualified research for purposes of the California R&D
Credit must meet the following tests:
- Qualify as a business under IRC
§174.
- Be undertaken to discover
information that is technological in nature.
- Be undertaken to discover
information intended to be useful to develop a new or
improved business component of the taxpayer.
- Substantially all (at least 80%)
of research activities involve a process of
experimentation.
Claimed California R&D credits more than doubled from 2009
to 2013. The California Legislative Analyst's Office has
projected that the state credit usage will continue to grow
and exceed $3 billion in 2020.
Incubators and
Accelerators
Coinciding with the growth in startup
activity, a rise in the formation of local accelerators and
incubators has taken place in recent years to provide the
necessary funding and expertise to help these startup firms
grow.
Several notable organizations in the
area providing support to startup firms include:
- Amplify: four month
program that provides free workspace and professional
services to member companies, in addition to mentorships
and educational workshops
- Idealab: provides
capital and a full range of resources to selected
companies; 40 of its member companies have been acquired
or successfully filed for IPOs
- TYLTLab: provides
capital and business planning, marketing and consulting
services to early-stage startups
- Media Camp: three
month program that provides weekly workshops and
networking events for companies with a focus in media
technology
Additionally, numerous colleges in the area have launched
incubator programs to offer services and resources for
companies founded by alumni and current students. These
programs (along with many others not listed) provide
invaluable opportunities for founders and employees of Los
Angeles startups to learn business skills, meet key people,
and hone their technological crafts.
Conclusion
Los Angeles tech industries are innovating
at a rapid pace. Companies in the area are spending billions
on a wide array of research and development activities, making
both the federal and California R&D tax credits lucrative
to pursue. These companies that are creating highly innovative
products and processes should consider these tax credit
opportunities not only as a way to provide a tax benefit to
shareholders, but also to fund future activities.
