April 18, 2017
What is the R&D tax credit and how does it work?
The research and development tax credit was enacted in 1981 to promote innovation and keep jobs in the U.S. A major regulation change in 2003 opened the door for small to medium size businesses to take this credit. The benefit can vary based on a company’s fact pattern, but as a rule of thumb, a company with $500,000 of qualified R&D costs can see a federal credit benefit of $25,000 to $35,000. Many states also offer an R&D credit which can double the benefit and can be refundable in certain states. Thus, the total credits on $500,000 of qualified R&D costs may exceed $70,000.
The R&D credit is a permanent credit and computed annually, providing a nice annuity for the company taking advantage of the credit. The R&D tax credit can be determined for the current year as well as other open tax years. A 2016 law change now allows the credit to offset Alternative Minimum Tax for companies with less than $50M in revenue—making the R&D credit more beneficial than ever.
How do I qualify for the R&D tax credit?
Qualification for the R&D credit revolves around activities where the design is uncertain and there is an assessment of alternatives, including the design, materials used, or environmental considerations. A listing of activities that may qualify for the credit include:
When performing design services for customers, the terms of the agreement between the contractor and its customer are important since R&D credits are only eligible for the party that bears the economic risk of the design efforts. As a result, R&D credits are more likely to qualify for work performed on fixed price or lump sum types of projects.
What is our process?
Our process is a three-step process. First, there is a general feasibility call to answer questions and better understand the R&D activities. This is a complimentary analysis during the pre-engagement phase. If agreed upon, a phase 1 assessment is performed which involves meeting with the company, discussing the credit rules and what activities qualify, and working through an initial calculation to estimate the federal and state R&D credit benefit for all open tax years. Phase 1 is typically performed at a nominal fee and involves an investment by the Eide Bailly team. After phase 1 is complete, the company and the Eide Bailly engagement team discuss and determine the scope of phase 2 and for a fixed fee, perfect the credit numbers through additional interviews and review of available information, and document the qualified activities through write-ups and the collection of contemporaneous documentation around the qualified activities.
What information is needed to claim the credit?
In general, the company will need two types of documentation. To compute the credit, the company will provide wages for individuals involved in the R&D, as well as a percentage of time that they spend doing R&D activities. Time tracking can be helpful, but is not a requirement. Estimates are acceptable for determining the amount of R&D time. The company will also provide total supply costs and third party contractor costs related to the R&D. The information will be gathered for the current year as well as prior years to compute the credit.
In phase 2, contemporaneous documentation is collected to support the qualified activities. The company will generally provide the following types of documents: project charters, power point presentations, design documents, emails discussing technical challenges, drawing iterations, or test reports to support their R&D activities. Our process utilizes the documents the company already generates and adds additional support through the interview process.
An architectural firm specializing in the design of hospitals with $13M in annual revenue and performing most of the work on fixed price contracts recently completed an R&D study with Eide Bailly. A one year study resulted in $2M in qualified wage expenses and $235K in federal and state R&D credits.
A mechanical contractor designing and installing mechanical systems for various office, municipality, and medical facilities with $20M in annual revenue recently claimed $60K federal and state R&D credits. The mechanical contractor had more than $600K of qualified expenses as their employees were assessing constructability issues, value engineering and providing mechanical design services.
A general contractor working on commercial, governmental, and industrial projects recently concluded a three year R&D study. The R&D study resulted in $130K in state and federal credits. The contractor worked on several large design-build projects each year and performed most of these projects on a fixed price basis. The work in the preconstruction phase included preliminary design and constructability issues. The general contractor had $500K to $1M of qualified expenses in each year and has an annual revenue of $50M.