Engineering Research & Development Tax Credit Study
How can engineering qualify for the R&D tax credit?
The R&D tax credit (officially “Credit for Increasing Research Activities”) is a dollar-for-dollar reduction to your tax liability and can amount to large savings, not just this year, but retroactively as well. Despite being a huge benefit to engineering companies around the country, the credit it is often overlooked by both big and small companies. From pre-bid meetings over the project specs and concepts to AutoCAD and prototypes, there are qualified activities throughout the engineering process. Our R&D credit specialists stay current with relevant IRS whitepapers, regulations, and case law. This accounting and legal knowledge coupled with extensive experience working with a variety of engineering firms gives us the expertise to assist any engineering company with their R&D tax credit claim.
The internal revenue code, section 41, outlines the requirements for the R&D credit, however, the high-level requirements for an activity to qualify can be summarized by the “four-part test” as explained in the right column.
If your activities satisfy this four-part test, the associated wages, supply costs, and/or third-party contractor expenses could qualify towards the tax credit. We often see the credit amount to 10% of those qualified expenses.
Example of qualified activities
If an electrical engineer ($100,000 in 2020 wages) spent the entirety of 2020 developing the electrical system designs of a new product in AutoCAD, the tax credit for their development efforts could amount to $10,000. Furthermore, if the employee assisted with the development of a working prototype and the raw materials associated with the prototype amounted to $50,000 you could be eligible for an additional $5,000 in tax benefit, or a combined $15,000.
All employees involved in the development efforts associated with the purpose of improving the manufacturing process or developing the prototype are eligible for the credit. From meetings with potential customers to discuss the specifications and requirements of the product to testing the materials used in the prototype, a variety of activities and expenses associated with the development efforts can be taken via the R&D tax credit.
In 2019, Calvetti Ferguson completed a 2015-2018 R&D study for a Fort Worth engineering firm with annual revenue of $35M and a payroll of $16M. Their services included mechanical, electrical, fire protection, civil/structural engineering design projects around North America.
The study resulted in a dollar-for-dollar federal tax refund of $200k in 2016, $300k in 2017, and $280k in 2017. It also resulted in an immediate tax reduction of $215k on their originally filed 2018 return, for a grand total of just under $1,000,000 in benefit.
While the scenario highlights the benefit attributable to the activities of one employee, an R&D study evaluates the entire company’s operations, often resulting in hundreds of thousands in tax savings/refunds. Our study process is unobtrusive and thorough to ensure you get the credit you deserve, while also staying within the letter of the law.
- Developing new and innovative designs for structures
- Designing and developing new or improved machines, equipment, or tooling
- Development of MEP System designs
- Preliminary design discussions with clients over technical requirements and specifications
- Development of engineering drawings and specifications
- Designing and developing new or improved systems, materials, or products
- Evaluation of alternative materials for construction
- Determining alternative structural designs
- Evaluating alternative subcomponents, methods, and materials for use in designs
- Environmental impact studies
- BIM or CAD modeling/simulation for testing and evaluation purposes
- Implementation of counter-terrorism capabilities
- Evaluation of alternative means and methods of construction
Four part test:
- Technological in nature: Development must rely on the principals of a hard science (mechanical/ electrical/industrial engineering, physics, biology, chemistry, etc.).
- Permitted purpose: Must develop a new or improved product, manufacturing/assembly process, formula, invention, software, or technique for the purpose of performance, functionality, quality, or reliability.
- Eliminate uncertainty: During the development of the “business component”, you must encounter uncertainty regarding the final design, the methodology of achieving the desired outcome, or capability of achieving the desired outcome.
- Process of Experimentation: To overcome the uncertainty, you must evaluate one or more alternatives in a systematic way. often times this is done via systematic trial and error, modeling, simulation, and/or software (such as SolidWorks, AutoCAD, etc).
Calvetti Ferguson works with mid-market companies, nonprofit organizations, and high net worth individuals across the country. Regardless of the complexity of the compliance, assurance, advisory or accounting need, our team stands ready to assist you. Please complete the form below, and we will follow up with you shortly.