Designers Qualify for the Research Tax Credit Presented by: Dawson - PowerPoint PPT Presentation

Congress’ Definition of R&D: Why Designers Qualify for the Research Tax Credit Presented by: Dawson Fercho, EA Corporate Tax Advisors, Inc.

Dawson Fercho, Founder-Partner ▪ IRS S Enr nrolled olled Agent ent- Admitted to practice before the Internal Revenue service ▪ 20 years of consulting experience Small and Mid-size businesses. ▪ 14 Years exclusively focused on the Federal Research Tax Credit & 179D Energy Efficiency Deduction. ▪ Co-Founder of Corporat porate e Tax x Advisors, sors, Inc. ▪ Responsible for all areas of client service and overseeing CTA’s marketing and business development. 2

Agenda ➢ Overview of the R&D tax credit ➢ The definition of R&D under current law ➢ Review examples of the credit computation ➢ Important tax rules to consider ➢ Types of industries and activities that qualify for the R&D credit ➢ Financial risk required in R&D activities 3

Section 41: Credit for Increasing Research Related Activities • Permanently Codified January 1, 2016. • Initially established 1981- Reagan Administration. ➢ Generates immediate cash flow by minimizing current tax liability • $1 for $1 tax credit- usability to pay down Federal Tax Liabilities, *State Tax Liabilities • Congressional Intent: Reducing the high-cost of U.S. Labor. • 4 Year Look. I.e. 2015-2018. • Open to All Tax payer entities- Sole, S. Corp, C. Corp, PSC, Partnerships etc. • Except non-tax paying entities. I.e. Fully owned ESOP (S. Corps), Non-Profit. • Primarily Direct Labor Expense Drive. 4

Be Aware The Research and Development (R&D) tax credit is one of the most substantial incentives under current U.S. tax law for the A/E industry. Unlike a standard deduction, it is a dollar-for-dollar credit against your tax liability. Desig ign n Life fe Ma Maga gazin ine e 2015 15 - Innovation begins with a design - Designers are by nature and profession, innovators - Innovation is seeing what is not working and initiating change I.E. How many designers does it take to change a light bulb? Does it have to be a light bulb? 5

What’s on a CFO’s MIND 6

What Does this Actually Mean? At 10% At 20% At 30% Pretax margin Pretax margin Pretax margin Cash flow from R&D Tax Credit 50,000 50,000 50,000 Estimated tax rate 26% (federal & state) 26% 26% 26% Revenue required to generate cash flow created by R&D credit 675,676 337,838 225,225 7

High-Level Estimate- Mental Calculation 1) Det etermi ermine ne Avera erage ge Annual al Direct ct Labor or Expen ense se 2) 25% X’s Director Labor Expense = Qualified Research Expenses 3) 7.5% X’s Qualified Research Expenses = Annual net Federal Tax Credit 4) #3 X’s 3 =‘s Total Federal Credit Benefit for Open Tax Years 2016 -20 2018 18 5) #4 X’s 15% to 25% = Potential State Research Tax Credit Benefit 8

Qualifying Research Expenses ➢ WA WAGES Salaries and Wages ▪ Typically largest component Supplies ▪ Calculate the % of employees’ qualifying Contract Costs time/hours ▪ Multiply this % by annual wages per W-2 ➢ SUP UPPLI PLIES ES ▪ Expendable materials consumed ➢ CONTRACT RACTOR OR COSTS ▪ Same pro-rata rules as above ▪ Only 65% of qualifying costs eligible 9

Qualified Research Expenditures IRC Section 41- Congresses definition of R&D: The development of a new or improved business component. I.E. New or improved Design “Four - Part Test” 10

The “Four Part” Test Part 1: Development of New or Improved Business Component (DESIGN) Six x ca catego gories: ies: ▪ Products oducts (t (tang ngible ible or r int ntangible), ngible), ▪ Proce cess, ss, ▪ So Software are, , ▪ Tec echni nique ues, s, Attempting New/Improved ▪ Form rmulas, ulas, Business ▪ Invention entions Component 11

The “Four Part” Test Part 2: Elimination of a Technical Uncertainty Endeavoring to discover information uncertain at Appropriate outset and final design 12

The “Four Part” Test Part 3: Technological in Nature Principals of science - engineering, physics, chemistry, biology, or computer sciences must be applied Relying on Principles of! 13

The “Four Part” Test Part 4: Process of Experimentation Evolution of Design, Trial ial and nd Er Error or Evaluating one or more alternatives 14

What is R&D per Congress? The “Quick Test” Qu Question stion #1 ➢ Did you do any conceptual thinking on a technology based problem? 15

What is R&D per Congress? The “Quick Test” Qu Question stion #2 ➢ Did you attempt the above in an effort to make something better? 16

Types of Qualifying Activities Design ideas that stretch current engineering expertise; ▪ Use of 3D modeling; ▪ Integrate alternate materials ▪ Improved acoustical qualities; ▪ Alternative water flow/plumbing systems; ▪ Alternative electricity conduction systems; ▪ Improving lighting; ▪ Improved ventilation; ▪ Alternative heating and cooling systems; 17

Types of Qualifying Activities- Engineering ➢ Alternative structural design; ➢ Waste and toxic waste disposal processes; ➢ Product and material transportation systems; ➢ Integrating environmental impact studies; and ➢ Integration costs related to designing co-dependent features. ➢ Material Strength Testing ➢ USE of CAD/CAM to evaluate various configurations ➢ Reviewing two or more site layouts to identify the best solutions ➢ Performing roadway simulations to determine the effect on traffic patterns 18

Types of Qualifying Activities: Architecture ➢ Developing unique energy efficient features ➢ Designing master plans ➢ Developing schematic designs ➢ Developing planning and elevation drawings ➢ Designing a functional site plan to incorporate or overcome various environmental concerns ➢ Developing construction documents ➢ Designing and developing building facades 19

Types of Qualifying Activities: Architecture ▪ Designing unique water treatment plants to optimize plant capacity or efficiency ▪ Designing innovative sanitary sewer systems for new residential communities ▪ Designing unique water pipeline and ancillary systems ▪ Designing innovative lateral force resistant systems for buildings ▪ Implementing dampening systems for buildings to account for dynamic loads ▪ Designing marinas to meet unique structural and load requirements ▪ Typically designing and developing activities (CAD,CAM) ▪ Typically not surveying or project management activities 20

Regulatory Changes ➢ The requirement to disclose contemporaneous record-keeping (timesheets) was eliminated in December of 2003, along with the Discovery Test. ➢ There is significant case law supporting a taxpayer’s ability to estimate how much time is spent on Research & Development 21

Funded Research ➢ Fixed ed Pric ice e Contr tracts cts The nature of fixed-price contracts puts financial risk on the taxpayer ➢ Pure re Time me and Mater erials ials and Level l of Effor ort Typically viewed as funded, but there are a few exceptions ➢ Cost st Plus/Tim us/Time e and Materials erials Contract tracts Although no inherently financial risk, the terms comprising Cost Plus and time and Materials Contracts may be balanced amongst the parties to determine which is responsible for incurring the cost, and thus the financial risk, to complete the final deliverable 22

Q&A 23

Contact Us If you ou have e an any y questions estions ple lease ase co conta ntact: ct: Da Dawson wson Fe Ferch cho 913-461-6179 direct dawsonf@corporatetaxadvisors wsonf@corporatetaxadvisors.com .com 24

How is the R&D Credit Computed? ➢ Total QREs are computed ➢ Base Amount is calculated – this is the difference in the two methods ➢ Regular Credit Method – Fixed base percentage multiplied by average gross receipts ➢ Alternative Simplified Credit (ASC) Method: one half of the average of prior three years QREs ➢ Costs above the base amount are multiplied by the credit rate, either 14% or 20% ➢ Result is “tax - effected” by the 280C election or the taxpayer’s actual tax rate 25