Written by Barry Devine, MBA, Regional Director, Tri-Merit
By now, most Architecture & Engineering (A&E) firms have heard of the benefits of the Research & Development (R&D) Tax Credit. Basically, by reducing the amount of tax that you owe, R&D tax credits improve cash flow significantly.
Take note that the R&D tax credit isn’t a tax deduction. It doesn’t decrease the taxable income of a company. Instead, it directly decreases a business’ tax liability. R&D tax credits give companies a dollar-for-dollar tax reduction.
When you claim research and development tax credits you…
- pay fewer taxes. Businesses enjoy a huge reduction in current and future years’ federal and state tax.
- increase cash flow. Companies have more financial resources for business growth and expansion. Those who take advantage of R&D tax credits are more able to stay competitive, explore new markets, and generate more jobs.
- can file a claim, regardless of your industry. Any business, small or large, can file a claim for research activities, including architecture, engineering (structural, geotechnical, civil, etc.), construction, and more.
How do A&E firms identify the activities that might qualify, and how do they establish the proper numbers to calculate the credit?
These are great questions, and the answers are found in a proven R&D study methodology which includes an analysis of project-accounting data supported by proper documentation and substantiation techniques.
Methodology
So, just what does an R&D study do? At a high-level, the study process brings together the qualitative vs. quantitative components of the credit.
The name of the credit is actually the “Credit for Increasing Research Activities,” so first we need to identify the activities that qualify. Then, we monetize those qualified activities.
Sound easy?
With the proper knowledge of IRS rules and regulations, as well as the ability to understand how they apply to your business, it can be.
However, be aware there are many methodologies used to calculate the credit, and not all are created equal.
At this point, you may be wondering what activities qualify for engineering firms and how you know which contracts have rights and risk (commonly referred to as the risk test and the rights test).
There have been several favorable court cases for helping navigate the area of funded research for the industry and what types of contracts qualify or do not qualify, based on the fee structure of the contracts.
These topics can get very technical very quickly, so we’ll save them for another blog post—stay tuned. For now, let’s talk data.
Project-Accounting Data Analysis
The analysis starts with using project-accounting data that the taxpayer tracks. The A&E industry is great about capturing data, but pulling the right information is the key. Here are some of the data fields that make the analysis process more efficient and the claim even stronger.
- Market Segment
- Service Line
- Project Type
- Contract Type
- Project Name
- Phase
- Task
- Employee
Qualify or Disqualify
The data set should be a four-year minimum if using the Alternative Simplified Credit (ASC) method or completing a study for the first time, as the files can get large and difficult to manage. The disqualification process can help, but it’s not a cut-and-dry process.
Let’s start by removing large sets of non-qualified data, internal charge codes, PTO/bereavement, admin functions codes, what about the company holiday party?
Even though it was virtual this year, you had to put those hours of drinking in your make-shift home office somewhere.
What about other groups of projects, construction administration, expert witness, interior design, or sitting at the government buildings waiting for permits? Is that a charge code?
Project Qualification Analysis
This is the most critical analysis, and it takes great coordination and interaction with the engineers and project managers (PMs)—both the A&E firm’s PMs and the R&D specialist’s PMs. This is why hiring a great R&D consultant is important.
Pro Tip! Look for one that has engineers and technical staff that can make the 4-Part test sound cool and exciting!
Allocate Time
Once projects have been placed in either the qualified (Q) or not qualified (NQ) category, we can allocate time to project sub-tasks.
Schematic Design (SD) and Detailed Design (DD) are the first that come to mind, followed by bidding, pre-design, construction docs, etc.
Basically, the development lifecycle activities can be given a percentage allocation to signify which hours on the projects are added to the credit calculation.
Employee Review
Once the analysis is complete, the data will generate qualified hours by employee. We recommend a final review of the employee list just to make sure the janitor or other support personnel aren’t showing up in the schematic design phase or another misallocated location.
Review and Substantiation
Now that you have your calculations, and every technical person is excited to have contributed to the owner of the flow-through entity saving money, that’s it, right? Not so fast!
The IRS still requires something called contemporaneous documentation. Luckily, you don’t have to create any new documents. In fact, the IRS does not want new docs, that’s why they use the word contemporaneous, which means occurring during the same period of time.
I’m paraphrasing, but that’s basically what it means. The IRS wants to see the documents that the qualified technical people created while they were performing the qualified activities during the qualified phases.
In my experience, collecting the data can be more difficult than it seems. Again, utilizing a consultant with great PMs is a key factor in developing a rock-solid claim!
Partner with Tri-Merit!
Now you know what some of the critical components are to a great R&D study and what to look for in a great provider.
It starts with a solid methodology and excellent project managers that have the technical expertise to understand the IRS side of the credit as well as the operational side of your firm and your clients’ business
Pair this with a thorough and complete review of your project-accounting data, along with the means to collect the relevant documentation, and you are off to a great start.
It also helps to work with a firm that values the relationship you have with your CPA and that can provide audit defense in case you encounter any issues down the road.
If you want to learn more about how R&D tax credits can benefit your business, or what makes Tri-Merit stand out from other firms, email us at info@tri-merit.com or give us a call at (847) 637-5677!
Take a look at research and development tax credit services!
