Has your engineering firm considered taking advantage of the Research & Development Tax Credit (R&D Tax Credit)? Contrary to the belief, engineering firms practice “innovation-like” work on the regular, which is considered R&D-worthy in the eyes of the IRS.
There is a common misconception that the R&D Tax Credit is only for companies with employees in white lab coats. However, this is far from the truth. In the past, most engineering firms couldn’t benefit from the Credit, however, when the PATH Act passed in 2015, this opened the doors for firms to take advantage. We will go further in-depth on what this means later in the article.
The R&D Tax Credit is for U.S. based companies who create, problem solve, and innovate. This Credit is an incentive to reward companies who are innovating and problem-solving with American ingenuity. Therefore, any off-shore work won’t qualify. The R&D tax credit offers substantial tax benefits to businesses of every size and in a wide range of industries, including engineering.
How does one determine if work is R&D worthy? First, you have to identify if the project, initiative, and or agenda you’re working on is considered a product. A product is what you make and sell for a profit. For example, as an engineering firm, the design process from start to finish is your “product”.
The next step is to run it through the Four-Part Test. We have a blog post explaining the Four-Part Test in greater depth. If you pass all four parts then it is deemed a Qualified Research Activity (also known as a QRA). The good news for you is, almost all of the work engineering firms partake in on a daily basis are considered QRAs. It’s to your benefit to find out if what you’re doing is qualifiable.
Check out the below examples of engineering-based QRAs, that are common during day-to-day operations. Please note that just because you don’t see some of your daily tasks below, doesn’t mean that they wouldn’t qualify.
- Structural design of new buildings
- Mechanical and electrical engineering design efforts to complete a construction bid package
- Concept designs to meet specification requirements
- Designing innovative technologies to address specific requirements
- Developing validation methods to ensure test accuracy
- Consideration of different building materials and the selection of equipment
- Improvement of construction processes for more efficiency
In order for activities to qualify for the R&D Tax Credit, the engineer must be finding or creating new and innovative ways to complete the task.
When the R&D Tax Credit was first introduced, engineering firms that were organized as S-Corps or Partnerships did not benefit from the Credit due to the Alternative Minimum Tax (AMT).
AMT is an additional income tax that is parallel to regular income tax. Taxpayers above a certain income threshold must determine their tax liability for both regular and AMT. Whichever amount is the highest is what is owed.
Simply put, engineering firms were partaking in QRAs. However, the R&D Tax Credit didn’t reduce their tax liability because they were already at, or near, the minimum amount of tax they were required to pay, the AMT.
Luckily, in 2015 the PATH Act was approved, which now allows the shareholders/partners of these firms to lower their personal tax liability BELOW the AMT for the first time in history! In addition, because taxpayers are allowed to go back up to three years and amend tax returns to claim tax credits they have previously not taken, this can mean a significant influx of cash. This is especially crucial during these challenging times when cash is needed the most.
The overall benefit of the R&D Tax Credit is that it brings “unfound” cash to the company. The R&D Tax Credit can minimize your tax burden and drive your cash flow profitably.
If you would like to learn more about how your engineering firm can benefit from the R&D Tax Credit, we recommend scheduling a quick 15-minute discovery call with our team of R&D Tax Credit experts. Select the below button to begin.