Posted on Dec 7, 2017

R&D Credit Qualification

According to our project partner, CTI, some specific examples of qualifying research activities that architecture and engineering firms have conducted in the course of business include, but are not limited to, the following:

  • Experimentation with natural ventilation
  • Energy analysis of exterior wall systems and building envelope
  • Occupant thermal comfort conditions
  • Exterior environmental effects
  • Design criteria for spatial configuration
  • Analysis of transient heat transfer for exterior building envelope
  • Energy analysis of multiple skin wall
  • Renewable energy systems performance analysis optimization
  • Performance/cost analysis of PV system
  • Solar energy design and daylighting analysis for temp regulation
  • Heat transfer and dew point analysis of exterior wall
  • Analysis for heat transfer coefficient various materials of walls
  • Performance and cost analysis of photovoltaic system
  • Life cycle cost analysis of building integrated photovoltaics
  • Solar hot water system design and testing

There are also activities that do not qualify for the credit, and it’s important to know some of these examples up front before considering an R&D study:

  • General capital expenditures
  • Training
  • Selling existing products
  • Travel expenses and administrative expenses
  • Routine data collection; routine quality control
  • Marketing or market research
  • Activity related to management function
  • Reverse engineering
  • Funded research (Grants and Contracts)
  • Research outside of U.S.

Excluded Activities 41(d) (4)(c)

  • Research after commercial production
  • Adaptation of an existing business component
  • Duplication of an existing business component
  • Efficiency surveys
  • Research in social sciences

As you can see, the Qualifying Research Expenses (QREs) must be related to new or untried experimentation in design. The research itself must not be funded, but done in the course of normal business activities. The firm assumes all rights and risks for the research.

The final test is defense and representation of an R&D tax credit claim with the IRS. Substantial claims are likely to receive an IRS query or audit. Strong data review, accurate calculation and documentation guidance by an experienced R&D study expert are critical steps to support your firm’s ability to claim this valuable federal credit.

Talk to the tax team at Cornwell Jackson about your potential R&D qualifying activities. We can review your data to discover qualifying research expenses and help you decide if an R&D study would be financially valuable for your firm.

Download the Whitepaper: Take Another Look at R&D Credit Qualification

Gary Jackson, CPA, is a tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax planning to individuals and business leaders across North Texas. Contact him at gary.jackson@cornwelljackson.com.

Posted on Nov 27, 2017

R&D Credit Qualification

R&D Study

If it is determined in the course of our tax consulting that your firm could qualify for a substantial R&D tax credit, we may suggest a third-party expert to conduct a more extensive R&D study. Our team has experience with initial discovery and phase two project review and qualification for low to medium R&D activities, but we align with experienced tax credit project partners when considering complex or high R&D activities.

For architecture and engineering firms, most use some type of project accounting data that can help R&D experts analyze Qualifying Research Expenses (QREs). The most significant qualifiers or data fields to review include:

  • Contract type
  • Line of business or discipline
  • Project type
  • Phases, sub-phases or tasks
  • Employee hours, titles and departments
  • Subcontractors
  • Project location

This data should be reviewed prior to interviews with leaders or project managers. It will help the R&D expert determine the right questions to ask about each project. You may allow the expert to export the data or provide the expert with templates that include this information and other data requested.

The second phase of an R&D study is the Communications or Project Review Phase. The R&D expert will walk through the four-part test and discuss product development lifecycle to help the project team identify and qualify R&D activities. This phase may take some time to educate firms that are new to R&D QRE qualification, but mentioning the potential tax savings can support participation. Any qualifying activities will be identified by project and phases of development.

The third phase of an R&D study is the calculation of QREs. The R&D expert will review the ratio of each employee’s qualified research hours to total hours worked. Those possible taxable wages will help the expert determine wage expenditures linked to R&D. The same calculations will be made regarding supply costs, subcontractors and contract or agreement expenses.

The final phase of the R&D study is documentation. The QREs calculation will need to be documented to note the QREs by phases/tasks performed on qualifying projects. This level of detail will support a credit claim to the IRS for the current or previous tax years.

Documentation is Critical for R&D Study

According to Barry Devine, an R&D study expert at Corporate Tax Incentives, with offices in California, Denver, Atlanta and Houston, documentation is critical to achieving a successful IRS R&D credit claim. Documentation needs to happen during the normal course of business as a sort of data map to prove R&D activities. The documentation process should not overly burden the firm — once it’s set up, of course.

By following the firm’s standard project set-up guide, you should be able to locate documents consistently under the following categories or standard practices:

  • Document name
  • Location of document
  • Frequency document is generated
  • Document owner or author
  • Instructions to find and access the document
  • Testing results
  • Project timelines
  • Meeting minutes

Your firm may have the documentation in your system, but a consistent process for project documentation will make it easier to claim R&D credits now and in the future.

Talk to the tax team at Cornwell Jackson about your potential R&D qualifying activities. We can review your data to discover qualifying research expenses and help you decide if an R&D study would be financially valuable for your firm.

Continue Reading: Common Qualifying Activities and Case Examples of R&D Credit Qualifications

Gary Jackson, CPA, is a tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax planning to individuals and business leaders across North Texas. Contact him at gary.jackson@cornwelljackson.com.

Posted on Nov 14, 2017

R&D Credit Qualification

It may not be as easy for architecture and engineering firms to qualify for R&D credits, but that doesn’t mean it’s impossible. Now that tax reform may result in lower corporate tax rates, it’s a good time to investigate any R&D activities that occurred for the 2015, 2016 or 2017 tax years. Resulting credits could offset higher federal tax in previous years as well as state franchise or business tax collected in Texas. The first step is an R&D study.

R&D Credit Qualification

Sustainability has been a trend in architecture and engineering for many years. As professional service firms develop new processes and methodologies for making buildings stronger, more environmentally friendly or flexible for users, they may not be thinking about how this innovation could reduce their tax impact.

Once the primary realm of manufacturing or product developers, we know that research and development is happening in service-based industries, too. Due to some changes to federal tax law, options have expanded for more firms to access R&D tax credits. In addition, the digital solutions that companies use to track project costs and processes may make it easier than in the past to collect data and determine eligibility.

A recent case study of one engineering firm that underwent an R&D study found enough quantitative data on R&D costs to support refunding most of the firm’s federal tax liability for the three prior tax years. There was also enough carry-forward remaining to provide the estimated equivalent of an additional four years’ worth of credit. When the firm was audited, according to R&D study expert SourceHOV|Tax, the IRS audit was clean.

The data to support the credit came from the engineering firm’s experience with large government and corporate clients that would request sustainable structures and require new designs to accomplish it. The firm’s historical preservation projects also require new processes and methodologies to strengthen buildings and support longevity without compromising historical integrity.

If you have even the slightest sense that an R&D study could benefit your engineering, design or architectural firm, know that there are different levels of studies that can accomplish your goal. Most importantly, current discussions around tax reform make this 2017 tax year the best time to look into it.

Here’s why:

Tax Reform Encourages Closer Look at R&D Credits

Two years ago, federal legislation made the R&D Tax Credit a permanent business credit, which meant that business owners could now plan ahead for future tax years rather than guessing whether or not it would be available and for which types of businesses.  The credit was expanded to offset the Alternative Minimum Tax for private, Eligible Small Businesses (ESBs) with  gross receipts of less than $50 million. There is also a payroll tax offset up to $250,000 available to Qualified Small Businesses (QSBs) with less than $5 million in gross receipts that were started up to five years ago.

If they qualify, businesses can receive a credit for qualifying R&D expenses that may include the following:

  • Salaries and wages – mainly W2 (Box 1)
  • Supply costs – used or consumed during research and experimentation
  • Contractor costs – up to 65 percent of qualifying costs, including paying for rights and risks of R&D, which means assuming the risks of experimentation without any funding for it and having substantial rights to the research results

In order to quality for the credit, businesses must pass a four-part test related to their research and development activities in a given tax year.

Permitted Purpose – Is the activity intended to improve a business component’s functionality, performance, reliability or quality?

Technological in Nature – The activity performed must not rely on social sciences, but on the principles of physical, biological and computer sciences or engineering

Elimination of Uncertainty – The activity is intended to discover information to eliminate technical uncertainty regarding the capability or method for developing or improving a product or process, or the appropriateness of the business components’ design

Process of Experimentation – With the result being uncertain, the activities involved in trying to achieve the result must be experimental in nature, and include actual experiments and evaluation of one or more alternatives

A few of the qualifying research expenses (QREs) for architectural and engineering firms could happen during the Pre-Design and Bidding process when professionals may experiment with initial design and concepting. But the most significant QREs occur during the Schematic Design and Design Development phases. Professionals may need to evaluate, analyze and test concepts more heavily and also produce mock-ups of innovative or untried processes and methodologies for the client.

Your firm may have already conducted qualifying R&D in previous years and not realized that expenses related to that R&D could make your firm eligible for a tax credit. Fear not. R&D Tax Credit studies can look back three tax years to identify qualifying research expenses. The reason this may be significant for your business now is that tax reform may reduce corporate tax rates going forward. The potential for high tax savings through an R&D tax study won’t get any better than now if corporate tax rates drop for 2018.

The current R&D credit allows firms to offset federal taxation as well as state franchise or business taxes in Texas for tax years 2015, 2016 and 2017. For qualifying businesses, the resulting tax credits often outweigh the costs of an R&D study when you factor in the potential federal and state tax savings.

If your firm provides any of the following services, it is worth considering an R&D Credit Qualification tax study:

  • Architecture
  • Geotechnical services
  • Civil engineering
  • Structural engineering
  • Mechanical engineering
  • Electrical Engineering
  • Surveying

There are exceptions to R&D conducted in these disciplines, the main one having to do with funded research. If your firm is under contract and paid to conduct research or if you have received a grant to conduct the research, it may be hard to prove that your expenses qualify for a tax credit. A tax expert experienced with R&D tax credit feasibility like Cornwell Jackson can usually determine this factor early in the discovery process.

Talk to the tax team at Cornwell Jackson about your potential R&D qualifying activities. We can review your data to discover qualifying research expenses and help you decide if an R&D study would be financially valuable for your firm.

Continue Reading: What is an R&D Study?

Gary Jackson, CPA, is a tax partner at Cornwell Jackson. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing tax planning to individuals and business leaders across North Texas. Contact him at gary.jackson@cornwelljackson.com.