R&D Tax CreditOpportunitiesfor Engineering FirmsAre You Missing Out on Tax Savings?
BY Andy Walkeror many years, manufacturers and technology developershave evaluated their technical and manufacturingexpenditures to identify those that canbe both deducted and used to support a claim forR&D (research and development) tax credits. Thesecredits further reduce a company’s tax liability ona dollar-for-dollar basis. Few engineering firms,however, have taken advantage of this opportunity.These firms mistakenly believe they are not doing qualifyingR&D or underestimate the amount of their R&D. Still otherfirms mistakenly think that they do not qualify for R&D creditsif they have already deducted related costs.Does Your Engineering Firm Qualify?For your services to qualify, you have to meet a few requirements:• First, you have to be using technology (math, chemistry,physics, engineering, computers, etc.) to create or improvea product or process—an easy requirement for engineers tomeet. For the engineering firm this means delivering betterengineering services.• Second, there has to be some uncertainty, from the outsetof a project, as to whether it will succeed. Engineers oftenrespond to this requirement by saying that what they dois not uncertain: “Obviously the bridge can be built, that’swhy we were hired.” But knowing that something can bedone eventually does not negate the qualifying uncertainty;the path to the final solution still requires a hypothesis anda trial-and-error process to prove whether it works.• Third, you have to be engaged in a process of experimentation(trial and error) to generate data or information thatallows you to resolve the uncertainty.• Finally, the research endeavor has to be yours—not yourclient’s. If your client has agreed to pay you for yourresearch efforts, regardless of your success, then related R&Dexpenditures would go toward your client’s R&D credits. Inmany situations, however, you bear all, or at least some, ofthe risk and to that extent the R&D credit could be yours.Another example is if you have a fixed-fee contract witha client, your firm may be obligated to perform the researchneeded, regardless of the cost. Even if you receive progresspayments, you may be at risk if there is a chance you will haveto refund them if your research is unsuccessful. Another part ofthis requirement is that your firm must retain substantial rightsin the research it performs for its client.If you have an agreement that assigns all the R&D to yourclient and gives your client the exclusive right to use the resultsof the research, the research is not yours for R&D tax creditpurposes. However, if your firm retains a substantial right touse its work product, it may qualify. One important thing tokeep in mind is that activities do not need to be successful toqualify, and in fact, will sometimes not be successful due to therequired uncertainty involved.Expenditures That QualifyYour expenditures that can be counted toward R&D creditsare direct, supporting and supervising R&D labor, suppliesconsumed in the experimentation process (often in prototypes)and outside R&D contractors retained to help you.Equipment purchases and other costs that are being depreciateddo not count. But the labor to install the equipment mightcount if the definition of R&D is met.While some employees’ participation efforts in qualifyingR&D activities are obvious, like those of design engineersand software programmers, many are not. Often overlookedas R&D participants are the project supervisor and othersinvolved in making your firm’s processes more comprehensive,more efficient or more capable of meeting clients’ needs. Alsomissed are R&D participants working in “value engineering”and engineers assigned to clients’ plants who work on trials.Actual Client Engineering Firm ExamplesHere are some examples of qualifying R&D projects engineeringfirms have completed:• Design of a challenging building componentwww.esd.org | The Engineering Society of Detroit | 41