Are R&D Tax Credits too Good to be True? Not According to One CFO

As business executives, we’re all accustomed to being bombarded with get-rich schemes and short-cuts that inevitably end up being too good to be true. As the CFO of a firm with decades of industry experience, I thought we had a pretty good read on what engineering firms could legitimately do to optimize tax strategies. So, when we first heard industry folks touting the virtues of Research and Development (R&D) Tax Credits, our firm had a serious case of skepticism, especially since we didn’t operate in the R&D sector.

However, when my firm experienced a flat year of revenue, combined with a highly successful collections process, a significant "deferred” tax liability suddenly became a "current” tax liability in excess of one million dollars. So, we decided to take a more serious look at R&D tax credits.

To gain a true understanding of the legality and application, it was a priority to find true experts in the field. Since R&D tax credits are a specialized area of the tax code, I needed a firm who could talk me through the reality of the opportunity and answer all of my questions. I was ultimately convinced of the application and legitimacy, but it still needed to pass the scrutiny of our seasoned accounting firm.

Following a full review, our accountant without hesitation simply replied: "Sure, you can do that." After the initial frustration with our accounting firm for not bringing the idea to us, we embarked on a four-month process that offset the entire million-dollar tax liability. We even built a surplus tax credit that we could carry forward as an asset on the balance sheet increasing the stockholders' equity. Even without a tax liability, R&D credits can offer significant advantages.

Jordan Wilson - Corporate Tax Advisors

After living through the process of evaluation, preparation, and actually being able to use the credits without triggering an audit or any other consequence, I understood why this program was so beneficial for AE firms and our industry in general. So, I wanted to put together some commonly asked questions and dispel some myths that cause many businesses to pass on this completely legal way to reduce tax liability and finance internal growth. Since these myths are best explained by true experts in the field, I turned to my trusted advisor, Jordan Wilson, whose company, Corporate Tax Advisors, has been helping firms in the AE industry for the past decade.

Research & Development Tax Credit Origins

The first R&D Tax Credits came to life back in 1981 with Ronald Regan’s backing. While the availability of credits and eligible industries have changed over the years, the intent has remained the same. The purpose then, as it is now, was to encourage the types of innovation that have historically allowed the US to be the dominant economic force globally. This position brings benefits such as stability, employment, etc. And these tax credits incentivize our industry to embrace innovation, which benefits all firms.

Myth #1

Only a very narrow set of businesses can apply for and use the credits. Most people assume that only scientific firms with “technology” in their name are eligible.

Reality: Any company that designs, develops, or improves products, processes, techniques, formulas, or software may be eligible. The terms Research and Development relate to the development of a product or process before commercial production for related U.S. activities.

Engineering, architecture, manufacturing, software development, and other firms are eligible.

Myth #2

Applying for the R&D tax credit is “sketchy” and will result in an increased likelihood of being audited.

Reality: The tax code at both federal and state level is ultimately created at the direction of legislative bodies, who have a long history of incentivizing business behaviors that they deem to be of societal interest.

Stated another way, the program was created because the government wants to reward companies engaged in these types of activities, not punish them with audits or increased scrutiny.

Myth #3

My accountant is handling that...

Reality: Over 90% of accounting firms in the United States do not offer a credits and incentives service since this is a small piece of the tax code, ever changing and is generally overlooked unless they have a partner specifically focused on credits and incentives. Most of these credit programs are related to a job, product or an activity-based credit and require more data and interviews to collect. Accounting firms prioritize accurate tax preparation. They prefer collaborating with tax credit experts, like Corporate Tax Advisors, for these niche opportunities.

Myth #4

Even for companies in qualifying industries, the standards are so high that hardly any activity would qualify, or the gains from credits would not even offset the work to prepare the filings.

Reality: The definition of qualifying activity is quite broad, and the basic framework is public knowledge, known as the Four-Part Test.

The definition of qualifying activity is quite broad, and the basic framework is public knowledge, known as the Four-Part Test.

Four-Part R&D Tax Credit Eligibility Test in Detail

1. Permitted Purpose (or Qualified Purpose/Business Component Test)

An activity intended to develop a new or improved business component:

● Improves Function, Performance, Quality, or Reliability

● Form Can Be a:

○ Product

○ Process

○ Technique

○ Formula

○ Software

Ask Yourself: Has your company demonstrated that the information being discovered was to develop a new or improved product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, license, or further used in its trade or business?

2. Elimination of Uncertainty

An activity intended to eliminate technical uncertainty concerning:

● Capability

● Optimal Methodology

● Appropriate Design

● Process or Product Improvement

Ask Yourself: Has your company demonstrated that it tried to learn something new about the product or process being changed in order to improve it and has it demonstrated that the product or process could not be improved without going through this discovery process?

3. Process of Experimentation

Implementation of a systemic approach to identify and evaluate different alternatives to achieve a desired result by:

● Trying Different Technologies

● Several Iterations

● Modeling and Simulation

Ask Yourself: Has your company demonstrated that it went through a process of elimination, trial and error, or other evaluation of alternatives in order to arrive at the new or improved product or process?

4. Technological in Nature

Application of hard sciences principles, such as:

● Engineering

● Physics

● Chemistry

● Computer Sciences

● Other Disciplines

Ask Yourself: Can your company demonstrate that its development of a business component relied upon the principles of the physical or biological sciences, engineering, or computer science?

If you answered yes to each of the above, you’re in need of a free consultation. If you are still not sure, here are some typical examples:

• Developing alternative water flow / plumbing systems

• Developing alternative electricity conduction systems

• Developing or improving lighting within a structure

• Improving or developing alternative ventilation for a structure

• Improving or determining alternative heating and cooling systems

• Determining alternative structural design

• Developing a pilot plant to investigate the concepts of a model or process

• Designing features where there is technical uncertainty

• Conducting sustainable design

• Performing space utilization

• Experimenting with new materials and technologies

• Determining alternate materials with which to construct a structure or parts of a structure

• Determining alternate means of assembling and/or fastening component parts of a structure

How to Start the R&D Tax Credit Evaluation Process

You should first decide if you qualify for R&D Tax Credits. The next step is to have conversation with a specialty firm like Corporate Tax Advisors. Ensure your advisor only requires payment if you actually qualify for tax credits in order to truly minimize your risk.

It all starts with scheduling a free consultation at your convenience by contacting Jordan Wilson (jordanw@corporatetaxadvisors.com) or visiting the Corporate Tax Advisors website.

You’ll meet with their diverse team, which includes accountants, engineers, and lawyers, and they’ll get to know your business and confirm whether or not you qualify. If you do, they’ll work hand-in-hand with your team and primary CPA firm to ensure the process goes smoothly, the application is accurate, and it is integrated with your tax strategy.

Other Tax Credits for AE Firms

R&D Tax Credits are not the only government sponsored tax incentives for AE firms. Corporate Tax Advisors also support programs such as 179D Green Energy Incentives.