What is the Federal Research and Experimentation tax credit?
IRC §41 is an incentive to reward businesses for investments in developing new products and processes. Surprisingly, the IRS has a very strict definition of Research and Development. But once a project is qualified, allows the inclusion of more expenses than one would normally associate with R&D.
Is this a true credit or a deduction? And what is the difference anyway?
As the name suggests the R&D credit is a credit. It is designed to put money directly in your pocket. Since it is a true credit your tax liability is directly reduced by the credit amount. If this were a deduction, it would simply reduce your taxable income (and not be nearly as lucrative).
What are some good indicators of “qualified research”?
Product maturity, product & process innovation, and let’s be honest: the “coolness factor”. We love to work with companies that love what they do, and that often directly correlates to a high “coolness factor”.
How much can the credit be worth to my company?
Strictly speaking, the credit will be worth as much as 4.55% of your R&D expenditures plus any state credits that may be available. All-in-all we have clients that see close to 10% or their R&D spending coming back to them every year. Keep in mind that though the IRS definition of R&D may be quite particular; it probably encompasses more expenditures than you think.
What is the potential benefit from the R&D Credit?
The benefits include a direct reduction in your tax bill, a better understanding of your own R&D process, and hopefully improvements in cost accounting if necessary. This credit will add directly to your bottom line.
Is the R&D credit just another fancy tax shelter?
No, in fact it is wildly popular among legislators of both parties. The IRS wants companies to utilize this credit (if they meet the section 41 guidelines). As such, Congress has designated this a general business tax credit.
Will the R&D credit increase my chances of getting audited?
In short, yes it will, but only as it pertains to the Research Tax Credit. Taking the credit has only a theoretically small chance of expanding beyond the research tax credit itself.
Two reasons for this: One, the IRS does not do fishing expeditions, a general audit is only triggered by anomalies in data the IRS receives (from filings, etc) and sometimes through the IRS’s small random audit campaign. Secondly, R&D Tax Credit audits go through a different procedural loop than general audits -- mainly because their engineers are involved.
What happens if the R&D credit is audited?
Hull and Knarr provides comprehensive audit protection to its clients. If the IRS has any questions we will answer them for you. Our approach is to perform the work necessary to win an audit BEFORE the credit is filed.
I have a great accountant, why doesn’t he or she already do this for me?
The short answer: he or she doesn’t know how. The Research and Development Tax Credit is one the most complex and misunderstood tax incentives that the government offers. Your accountant probably has a cursory knowledge of the R&D credit, but does not have the engineering expertise to support a claim.
We have a great accounting firm, why do we need Hull & Knarr?
Hull and Knarr is not an accounting firm; and we are not in competition with your accounting firm. In fact, most of us don’t even do our own taxes. CPA firms simply do not have the engineering resources and/or staff to substantiate a claim and defend the claim should it come under scrutiny by a state or federal authority.
Why doesn’t my accountant know how to calculate the R&D credit?
We are sure he does know how to calculate the credit. He just does not know how to qualify the credit. The idea is somewhat analogous to the idea that just because you know how to drive a car does not mean you know how to build one.
Why does Hull & Knarr use Engineers to qualify companies for the credit?
Much of the confusion about the credit stems from the assumption that because it’s related to tax… it MUST be a function of accounting. While the final credit amount does end up going on a tax return, the correct methodology in getting to that number is a discipline of engineering.
How does the IRS know all of the technical issues behind whether my company qualifies? I thought the IRS was just a bunch of accountants.
The IRS uses their own engineers to audit credit claims; additionally, in April 2007 a technical directive was issued designating the research tax credit as a Tier 1 issue. The directive emphatically revised the IRS Field Agents’ audit approach to include extensive analysis of a company’s engineering merit. This aggressive change without a doubt makes the Research Credit an engineering-based credit.
Will a CPA be involved in my study?
Yes, the managing partner of Hull and Knarr is a CPA. He oversees all regulatory compliance and communication with the IRS. We are more than happy to defend our work!
What is the difference between a retroactive study and a current year study?
A retroactive study allows us to recover tax dollars from previous years. A current year study allows us to recover tax dollars on a “live” tax return. The initial study is usually retroactive, but could be for the current year only depending on your particular situation.
What is the study process like?
Hull and Knarr will begin your study with an informative kick-off presentation to begin the fieldwork. Next we will interview a cross section of your employees and work with accounting personnel to acquire the necessary documents. Next we compile a comprehensive report and calculation to support your claim, and provide all necessary information to your accountant to file your claim.
How much time is required for a typical retroactive study?
Hull and Knarr works to minimize the time required of your employees. In most cases interviews will last about 45 minutes each with a little extra time required for data collection.
Who at my company will need to be involved?
We will need to talk with a cross section of personnel potentially involved in qualified R&D. Typically, this group ranges from management and engineers, to quality control and production personnel.
How long will it take to complete the study after the fieldwork is complete?
We strive to complete each study within 6 weeks of fieldwork completion. If a unique situation requires a tighter turnaround we are happy to meet your needs.
I know some credits are available retroactively, how about the R&D credit?
The R&D credit is available retroactively. You can go back three years to file an amended claim based on when the original return was filed.
Is the R&D credit refundable or non-refundable?
The R&D tax credit is a non-refundable tax credit. Yes, this means we are limited by AMT issues at the Federal level. However, many states have no AMT limitations on the credit.
What if I have Alternative Minimum Tax (AMT) issues?
AMT issues are an ever-present problem. The credit can be carried back one year and forward 15. We will work with your accountant to determine if and when you may be able to use the credit.
New for 2010: Any Federal credits generated during 2010 may be used to reduce tax liability below AMT for eligible small companies. Eligible small businesses are sole proprietorships, partnerships and non-publicly traded corporations with $50 million or less in average annual gross receipts for the prior three years. If you have been limited by AMT in the past, this is the year to take full advantage of the Research Tax Credit.
There is a Federal R&D tax credit. Are there any state credits available?
Most states do have a credit available. There is not much uniformity to these credits; some are more lucrative than the federal credit, others less. Regardless, a reduced tax burden means money in your pocket.
Click here to view STATE R&D Credits.
How long has the R&D credit been around?
The R&D tax credit has been an incentive offered by the IRS since the early 1980’s. Since that time the credit has been permanently temporary.
What do you mean by the credit has been permanently temporary?
The credit has traditionally gone through a cycle of extension and renewal since inception. While the credit is popular with both sides of the isle, no one has had the political will power to make it permanent.
What does the future of the credit look like?
Thanks to the Emergency Economic Stimulus Act of 2008 the credit has been extended through 2009. And in fact the credit has been made more lucrative for calendar year 2009. Remember, many states have their own credit too.
How is the R&D tax credit calculated?
There are several calculation methods available. Which we use will depend on the intricacies of your situation and available information. We will provide more detailed explanation when the time comes (and you may end up wishing you didn’t ask).
Most of our research is government funded, can I still qualify?
Contrary to popular belief there are several ways for government contracts to qualify for the R&D tax credit. We will need to have a look at each contract, but these funded projects can often be used to generate a credit.
Where is Hull & Knarr located?
Greenwood, Indiana (south of Indianapolis, if we were across the street we would have the ritzy Indianapolis address)
What portions of the United States do you cover?
We will go anywhere in the United States and its territories. In fact, a large portion of our business comes from the East and West coasts. The managing partner has tried, to no avail, to find a customer in Hawaii!
We manufacture all or our products outside the United States, is there still opportunity for the R&D credit?
Yes, this credit is only concerned with where the R&D process occurs. You can move your production to the moon for all we care. Of course any R&D that occurs on the moon (or anywhere outside the US) will not be eligible.
We have offices in Canada and/or Mexico, how will this affect our credit opportunity?
Any activities undertaken outside of the US or a US territory are not eligible. Again, it’s where the R&D is performed.
Will Hull & Knarr need to be involved after the initial retroactive R&D credit study?
The IRS prefers that a study is conducted in some way year-over-year to maintain consistency. We have several different arrangements we can use going forward and will work to develop a plan to meet your needs going forward.
I have seen that the R&D credit is categorized as a “Tier One Issue” by the IRS, what does this mean?
Essentially this means the R&D tax credit is among the most scrutinized tax incentives the IRS offers. Our engineers ensure that your claim will withstand the increased scrutiny imposed by the elevated “Tier One” status. We actually agree with the IRS on the need for this scrutiny (SHHHHHHH!, don’t tell our friends)
What types of past accounting information and supporting documents are required?
To complete a retroactive R&D study, required accounting documents will vary. In a perfect world we would have all tax returns, W2s, and time tracking information back to 1984. Obviously, this is a bit of a pipe dream, and the IRS agrees. There are several ways to work around missing accounting records, though we will go to great lengths to recover historical records. However, sometimes we have to forgo retroactively and concentrate on taking the credit going forward.
What if I do not have past accounting information?
We will work to get the required information. At the very least we will help you maintain the appropriate documentation moving forward so we can calculate a credit in future years.
What if we do not have enough supporting R&D documentation?
Hull and Knarr engineers will take a comprehensive look at the available documentation. You will probably be surprised how much information we can turn up once we start looking.
What sorts of R&D documentation do you need anyway?
Common pieces of documentation to evaluate include: meeting notes, drawings, patents, test results and analysis, and anything that shows the R&D process and individual involvement.
Our product development information is very sensitive, do you really need specifics?
We always sign non-disclosure agreements, in fact many of our clients DoD contractors; and we will be glad to sign any other documents that will make you more comfortable. In order to maximize the credit opportunity we will need access to all parts of your R&D process, but of course we always work on a case-by-case basis.
We do not have any time tracking information; can we still generate a credit?
In most cases direct, project-based time tracking is the desired method. Also, in most cases this is not available. There are several methods we use to develop the required time allocation percentages of individuals involved in the R&D process.
How do I get more information?