Engineering firms have to start considering taking advantage of the R&D tax credits. As opposed to the common notion, engineering firms exercise innovative work regularly and may be highly considered worth the R&D qualifications in the vocabulary of the Internal Revenue Service.
A common misconception about the R&D tax credits grants is that it is solely for business entities that have their employees in white lab coats. Nothing could be farther from the truth with regards to R&D tax credits. It may be true that in the past most engineering entities could not take advantage of the R&D tax credits but since 2015 the passing of the PATH Act, the doors have been opened for them to benefit. In this article, we will further go on an in-depth discussion.
For business entities based in the United States that are involved in the creation, problem-solving, and innovation, the R&D tax credits present themselves as an incentive to reward such endeavors with American ingenuity. Any off-shore research and development project therefore will not qualify for R&D tax credits. The R&D tax credits allocate substantial tax benefits to entities of various sizes and ranges of industries, and you guessed it right, engineering is now one of them.
How to Determine If an Engineering Project Qualifies for R&D Tax Credits
So how does one determine if an engineering work is worthy of R&D tax credits?
First, one has to identify if the engineering project, its initiative, and its agendas worked on can be considered a product. A product can be defined as something that one can make and sell for a certain profit. For engineering entities, an example of this would be the design process from the beginning to the end is the “product”.
What is next to determine if engineering works qualify for R&D tax credits, is to run it through certain qualifying factors. When all the qualifying factors are passed, the engineering project can be deemed a QRA or qualified research activity. A good thing about engineering firms is that almost all of the projects they work on can fall under the QRAs category.
Here are some examples of engineering-based QRAs during daily operations:
- The design of innovative technologies to give solutions to specific requirements
- The development of validation methods for confirming test accuracy
- The improvement of construction processes to aid efficiency
- The design of structures of new buildings
- The engineering design efforts – mechanical and electrical – that complement construction bid suites
Take note though that just because the day-to-day tasks are done in your firm are not listed above that it does not qualify for R&D tax credits claims.
How Engineering Activities Qualified for R&D Tax Credits
To determine if engineering activities are eligible for R&D tax credits, the firm must find or create novel and innovative ways to complete the job. When the R&D tax credits allocation was first introduced, engineering entities could not take advantage of it due to the AMT or alternative minimum tax.
The AMT is the additional income tax that is equivalent to the regular income tax. U.S. taxpayers above a threshold of a certain income need to determine their tax liability for AMT and regular tax income. The amount higher than the other is what is owed to the IRS. To put it simply, engineering entities have partaken in QRAs only that the R&D tax credits did not effectively reduce their tax liabilities because they already have the AMT getting them at or near the minimum amount of tax they are required to pay.
Fortunately, in 2015 the PATH Act was approved and has allowed partners or shareholders of these engineering firms to lower tax liabilities with R&D tax credits further below the AMT for the first time in record. Additionally, since taxpayers are permitted to go back up to 3 years to amend tax returns and claim R&D tax credits previously not taken, it means a significant influx in cash flow for these engineering firms.
Best Practices in R&D Tax Credits Claim Preparation
Accounting firms need to ensure that clients like engineering firms have the tool and knowledge how to prepare a well-rounded and sensible R&D tax credits claim. Reliable accounting firms have advised on avoiding inquiries or writing technical narratives.
In their experience, there are keys to making a good R&D tax credits claims process. These include cooperation, knowledge, and consistency. These steps must be kept in the minds of engineering entities trying to go right with their R&D tax credits claims.
The first step in the preparation of R&D tax credits claim is to ensure that the engineering entity or client understands the criteria and guidance for what constitutes eligibility. Accountancy firms offering advice on R&D tax credits claim should have also spent some time studying the IRS qualifications.
Clients need to have at least a passing understanding of the salient parts of the guidance regarding R&D tax credits. At the end of the day, they are the ones who have detailed knowledge of their engineering projects and are the best people to identify whether their engineering projects are eligible, with the guidance of the accounting firm.
Once the accounting firm and the engineering firm client have enough knowledge to draft robust R&D tax credits to claim, it is now time for the accounting firm to think of the best way to work with the engineering firm through the process.
Reliable accounting firms assisting with R&D tax credits claims should vitally prepare the documents with their engineering firm clients, rather than for their clients. Hiring firms that prepare R&D tax credits claims without their engineering client’s input is rather risky and misguided. They can potentially be fraudulent at worst. Defending an R&D tax credits claim in the event of an inquiry can be incredibly difficult when the client has not been involved from day 1.
Remember that all R&D tax credits claim that are well-prepared and robust start with a consistent procedure. There is no right or wrong way to do R&D tax credits claims as long as stakeholders ensure that all the bases are covered. A great order of operations is as follows:
- Come up with a question list, report template, and breakdown structure of costs – this ensures that the output is the same throughout
- Conduct a structured interview with the engineering firm client regarding their carried-out projects within the claim period
- Juxtapose each of these engineering projects and details against the criteria and determine which to include in the R&D tax credits claim
- Determine with the engineering firm the identified costs for each of the engineering projects.
- Make a technical narrative, ensuring the demonstration of the engineering firms’ eligibility
- Make a breakdown of R&D tax credits and eligible claims
- Have the engineering firm review the narrative and costs and get them to sign-off
- Submit to IRS