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The Research and Development Tax Credit
The Research and Development Tax Credit (R&D Tax Credit) was created by Congress as part of the Economic Recovery Tax Act of 1981 to encourage American industry to invest in research and development activities. The purpose of the credit was to stimulate R&D activities among U.S based businesses through tax incentives.
Benefits to Clients
- Dollar for dollar reduction on current year's tax liability
- "Cash Tax" savings for open tax years where R&D activities were either not captured at all or were excluded from the original credit calculation
- Additional tax savings in future years given a twenty year carryforward if not utilized in the current year
Who can use it?
Many companies are not aware that they actually conduct qualifying R&D activities and are often surprised to find that the following industries qualify:
- Biotechnology
- Chemical
- Engineering
- Fabrication
- Food Sciences/Manufacturers
- Machine Shops
- Manufacturing
- Pharmaceutical
- Plastics Manufacturers
- Software Developers
- Tool and Die
Five Questions to ask when choosing an R&D Consulting Firm
During the due diligence process in selecting a consulting firm to perform your Research & Development Tax Credit Study, make sure the provider can answer the following questions:
1. Does the firm employ engineers?
Ask for the biographies of the individuals on the firm's production staff and determine if each individual involved with your Study is either an intellectual property attorney with an engineering background or an engineer.2. Does the firm use the Comprehensive Project-by-Project Methodology?
Ask if the firm will utilize the Comprehensive Project-by-Project Methodology as well as establish a detailed "nexus" of qualified research expenditures for qualified research activities. One of the IRS's biggest concerns is that some companies' "engineering" reports are in fact written by individuals with no engineering or scientific background and that "no nexus" is established between a company's qualifying expenditures and qualifying activities. The firm's documentation should directly connect the project to the employee and the estimated time spent on that project to each of the engagement years. This is the methodology most accepted by the IRS today.3. Does the firm assume most of the risk?
To begin a project, most firms will ask to bill by the hour (sometimes with a cap) or sell on a fixed fee. This approach carries significant client side risk because there are too many variables that simply cannot be foreseen at the beginning of the project. Choose a firm that is willing to assume most of that risk and, for a nominal fee, answer all of those variables by determining the following:
- What your credits actually are, per year
- What your exact utilization of those credits will be
- What your base percentage is and whether that affects your utilization
4. Does the firm include Audit Review as part of their fee?
The IRS has elevated Research & Development Tax Credit Studies to a tier one issue; as a result there is a greater chance for an audit. The onus is on the taxpayer to substantiate their credits. It is imperative that the firm chosen willing to stand behind their work (documentation and supporting calculations) and include the audit defense as part of their fee. Otherwise, you will be left with an open ended situation and you will have to pay that firm or legal counsel on an hourly basis.5. Does the firm have references to call?
Always ask for references, preferably those in your industry.
For more information about Research and Development Tax Credits, contact us.
