Has your engineering firm considered taking advantage of the Research & Development Tax Credit (R&D Tax Credit)? Contrary to belief, engineering firms practice “innovation-like” work regularly, 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, but when the PATH Act was 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 that 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 Do You Determine If Work Is R&D Worthy?
How does one determine if work is R&D worthy? First, you have to identify if the project, initiative, 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, it is deemed a Qualified Research Activity (also known as a QRA). The good news is, almost all of the work engineering firms regularly partake in are considered QRAs. Click here to see if your work qualifies as a Qualified Research Activity.
Here Are Some Examples
Check out the examples of engineering-based QRAs below 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.
- Designing innovative technologies to address specific requirements
- Developing validation methods to ensure test accuracy
- Improvement of construction processes for more efficiency
- Structural design of new buildings
- Mechanical and electrical engineering design efforts to complete a construction bid package
How Do Activities Qualify?
For activities to qualify for the R&D Tax Credit, the engineer must find or create new and innovative ways to complete the task. When the R&D Tax Credit was first introduced, engineering firms 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 income tax 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.
Things Changed In 2015
Luckily, in 2015 the PATH Act was approved and now allows the shareholders/partners of these firms to lower their 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 funds are 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.