Most pre-revenue founders assume tax strategy is something you think about when you have income. But there are things worth thinking about now. Many tax provisions, at the federal and state level, are geared toward innovation, research, and production. Some are well suited for pre-revenue companies with no income tax burden at all.
For biotech and medtech companies, the pre-revenue phase can stretch for years. You’re spending heavily on research, burning through runway, and generating no taxable income. That spending creates opportunities to implement real tax strategies. Some generate additional cash today. Others create assets on your books that will have value at acquisition or at profitability. And some are benefits that accrue to founders and early investors, but only if the groundwork is laid now.
1. No Income Tax Doesn’t Mean No Tax Strategy
Some federal and state tax incentives exist specifically to support companies during the pre-revenue phase and don’t require an income tax liability to access. The decisions you make now about how you classify expenses, document your research, and structure equity determine the size of the tax asset base you’re building. Getting those decisions wrong early is expensive to fix, and sometimes impossible.
2. Cash You Can Access Now
The Federal R&D Payroll Tax Credit Offset
IRC Section 41 governs the Research and Development tax credit. For most companies, a tax credit is only useful if you have income tax liability to apply it against. Section 41 includes a specific provision for early-stage companies: qualifying R&D credits can be applied against your FICA payroll tax obligations instead, up to $500,000 per year for up to five years. However, this credit can also be applied by post-revenue companies against income tax later on.
For reducing payroll tax, two conditions matter:
- Gross receipts for the current tax year must be under $5 million
- The company must have no gross receipts in any tax year preceding the five-year period before the current year
The second condition matters for biotech specifically. The five-year window starts when you first recognize gross receipts, not when you were incorporated. A company that spent its early years with zero revenue can still be within that window even if it has been operating for a decade.
Maryland R&D Tax Credit
Many individual states have their own R&D TAx Credit, this includes Maryland. In Maryland, the credit is refundable for qualifying small businesses, meaning it pays out even without Maryland income tax liability, putting cash back in the business during the pre-revenue phase. Certification through Commerce is required, and there’s an application process worth understanding before you plan around it. If you’re operating in Maryland, this is worth examining alongside the federal credit.
Sales Tax Exemptions on R&D Materials
Many states exempt materials, supplies, and equipment used in qualified research and development from sales tax. For biotech and medtech companies buying lab supplies, reagents, and equipment in volume, these exemptions can represent meaningful savings, particularly when cash is tight.
The mechanics matter here. In most states, the exemption isn’t automatic. You need to apply for the exemption, obtain the right documentation, and provide exemption certificates to your vendors. Companies that haven’t done this are likely paying sales tax they don’t owe.
Sales tax exemptions on R&D-related purchases vary across states, and the rules can be specific in how they’re defined and claimed. Colorado adds a layer of complexity. The state delegates significant sales tax authority to home-rule cities, which administer their own taxes separately from the state. Each home-rule jurisdiction has slightly different rules, but many offer exemptions that a research-focused biotech or medtech can take advantage of. Navigating that correctly requires familiarity with how each jurisdiction handles it. If you’re operating in Colorado, working with someone who knows the local landscape is worth the effort.
The practical step is straightforward: identify which exemptions apply in the states where you’re purchasing, get the documentation in place, and make sure your vendors have your exemption certificates on file. It’s one of the more direct ways to reduce cash outflow during the burn phase.
3. Your R&D Probably Qualifies for Credits, But You Have to Document It
The Section 41 credit applies to research meeting a four-part test.
Permitted purpose. The research must aim to improve or create something functional: performance, reliability, capability. The standard isn’t novelty in general, but that It’s novelty to your company. Incremental improvements qualify alongside breakthroughs.
Technological uncertainty. You don’t know whether the approach will work, whether the design is achievable, or whether the method is viable. Preclinical development, where you’re using a scientific process to establish whether a compound behaves as hypothesized, is a direct example of this.
Process of experimentation. The IRS expects a systematic process: problem identification, hypothesis formation, testing of alternatives. Lab notebooks, experimental protocols, and documented trial-and-error all serve as evidence.
Technological in nature. The work must be grounded in biological sciences, physical sciences, engineering, or computer science. For biotech and medtech, this should be easy to meet.
Qualifying expenses include wages for employees directly performing, supervising, or supporting qualifying research, supplies consumed in that research, and a portion of payments to third-party contractors. For companies working with CROs, external contractor costs generally are includable at 65% of the payment amount, but the arrangement needs to be documented correctly. If your CRO agreements haven’t been reviewed with the credit in mind, that’s worth addressing before you file.
4. Tax Assets You’re Building for Later
Net Operating Loss Carryforwards
When deductible expenses exceed gross income, the result is a net operating loss. Under current federal law, those losses carry forward indefinitely and can offset up to 80 percent of taxable income in future years. For a company burning through runway for several years before revenue, the NOL carryforward balance can be meaningful to offset future revenue.
One complication to watch out for is IRC Section 382. When a company undergoes an ownership change, defined as a shift of more than 50 percentage points among 5% or more of shareholders over a rolling three-year period, the annual amount of pre-change NOL that can be used is capped. A substantial fundraising round can trigger that limitation and should be taken into consideration in tax planning.
State R&D Credit Carryforwards
Several states offer R&D credits that, while not immediately refundable, can be booked as assets on your balance sheet and carried forward to offset future state income tax liability.
Of the states we most frequently support clients in, Maryland offers refundable credits, making this less of a factor. Illinois offers an R&D credit under the Illinois Income Tax Act that applies to qualifying research conducted in the state. Colorado offers a research credit under certain circumstances, with eligibility tied to specific program requirements. Both can accumulate during the pre-revenue phase and represent real value once you reach profitability. So, it is important that underlying research is documented correctly and the credits are tracked on your books.
If you’re operating in Illinois or Colorado and haven’t looked at what state-level R&D credits you’ve been generating, there may be an asset sitting unrecognized on your balance sheet.
The Federal R&D Credit Carryforward Pool
Unused federal R&D credits that can’t be applied against payroll tax can carry forward for up to twenty years and apply against income tax liability once you’re profitable. For companies conducting significant qualifying research over multiple years, this carryforward pool belongs on your balance sheet as a documented deferred tax asset.
5. Some Planning Only Works If You Do It Early
There’s a category of tax planning that involves how equity is structured, how early investors hold their shares, and how certain elections interact with a future liquidity event. Qualified Small Business Stock treatment under IRC Section 1202, 83(b) elections on restricted stock, and early exercise provisions are examples of provisions where the window is tied to initial issuance or early-stage company status. Once the moment passes, the opportunity is gone.
This is a conversation worth having well before you’re thinking about an exit.
Where to Start
Three questions are worth asking if you haven’t looked at your tax position closely.
Are you maximizing cash availability through credits and sales tax exemptions? Are your state R&D credits and NOL carryforwards being tracked on your balance sheet to create long term assets? Is your tax planning and fundraising integrated such that you are not inadvertently limiting an NOL carryforward balance?
None of this requires aggressive planning. It requires accurate books and an understanding of what the tax code offers companies doing the kind of work you’re doing.
My team at Bipanna works with biotech and medtech companies navigating exactly this. If you want to understand what your current tax position looks like, the first step is a 30-minute conversation. Reach out to set one up.
