This article was updated September 7, 2023.
The R&D tax credit can be a significant money-saving opportunity for companies that engage in qualifying activities; and over the past 10–15 years, new regulations, court rulings, and guidance from the IRS and state tax authorities have provided greater clarity on positions companies can take to increase the credit’s benefits.
In response to this uptick in R&D credit interest and availability, an increasing number of CPA firms and isolated service providers are advertising R&D tax credits, making it more difficult for companies to discern the differences in the services offered by each provider, which can vary significantly. To help select the right provider, there are three key attributes to consider:
- Fee structure
Engaging tax accountants who specialize in the R&D tax credit—and understand the ramifications of the tax laws and regulations that surround it—is essential to successfully claiming the credit. Some firms handle the R&D tax credit as a subset of the tax return preparation, but they might not have the depth of knowledge to properly address complex issues associated with R&D tax credits or, given their limited bandwidth, they could potentially overlook risk areas that could impact the sustainability of the credits.
Therefore, it is important to consider the following factors when evaluating a firm:
- Whether they have dedicated R&D tax credit service team
- The size of the team, which can be an indicator of whether a firm is an established practice
- The overall experience level of the provider
- Diversity in skillset
There are several factors that determine whether a provider can help a business recognize a credit. For example, the organization of a company and its related parties can impact the computation of a credit. Furthermore, depending on the company’s industry, there are different types of activities performed that could impact the qualification and quantification process. A provider should possess the technical tax knowledge and experience to help determine how the business structure and the related activities could impact the company’s R&D tax credits.
Section 174 Changes for R&D Expenses
The Tax Cuts and Jobs Act (TCJA) made significant changes to the way businesses can deduct research and experimental (R&E) expenses. Under the new rules, businesses are required to capitalize and amortize R&E expenses over five years for domestic costs and 15 years for foreign costs. This change has had a significant impact on businesses that incur R&E expenses, as it has reduced the upfront deduction they can claim for these costs.
In light of these changes, it’s even more important for businesses to carefully consider their choice of R&D tax credit provider. Businesses should look for a provider that has a deep understanding of the new Internal Revenue Code Section 174 rules and the impact they have on businesses' tax liability. Additionally, businesses should seek out a provider that stays up to date on the latest developments in R&E tax treatment, as the IRS is still issuing guidance on how to interpret and apply the TCJA's provisions. By working with a knowledgeable and experienced tax professional, businesses have a better chance at properly capitalizing and amortizing R&E expenses and claiming the R&D tax credit.
In the event of a claim challenge, a company would benefit from engaging a provider that can follow it through the examination process. Many firms have R&D tax credit experience but lack direct IRS and state exam experience. They’re likely to hand a case off to a tax controversy team that wasn’t involved in the original R&D analysis and will have to learn the details of the tax credits from scratch. Engaging a service provider that has a team dedicated to and experienced with both the R&D tax credit and direct IRS and state exam means they can hit the ground running should a company’s claim be chosen for examination.
For any company that has a significant R&D credit opportunity, a substantial amount of time should be dedicated to calculating and supporting the credits claimed. Here are some areas to pay attention to when evaluating a provider.
It’s often a red flag if a provider promises it will take a minimal amount of time to complete the work. Minimal time usually means minimal documentation—and providing numbers to the IRS without support and documentation is asking for trouble, as several recent court cases have shown. The amount of documentation, interviews, and time commitment of company personnel will vary depending on the amount of qualified expenses and activities.
A thorough review—one capable of withstanding scrutiny—takes time. And not just time on the part of the provider. A firm should ask for the hiring entity’s staff’s time as well because it will interview those employees—engineers, scientists, designers, project managers, and so on—who were involved in or performing the R&D projects as well as executives and financial personnel. These interviews will provide access to the right financial information to calculate the credit and understand the company’s acquisitions and dispositions from a tax perspective.
Scope of Work
When evaluating providers, make sure you understand the scope of work. To save on cost, some providers may cut corners and do the following:
- Not review high audit risk areas
- Generate minimal or no documentation
- Use generic or nonspecific statements to describe a company’s research activities
- Miss out on additional credit opportunities
- Fail to evaluate a credit computation method that yields best results for the client
Be wary of any provider that tries to cut corners. Attempting to circumvent the due diligence required to conduct a thorough R&D tax credit review by using industry averages or other shortcut methods of calculating the credit is fraught with risk. There’s no substitute for interviewing and obtaining documentation from staff, and addressing time spent with client staff have a much higher probability of a favorable result from IRS and state examinations.
Some firms include this, while others don’t. In the event of an audit, you want to know that the firm you used can help you and provide context to authorities on the work they’ve done for you.
Look for a firm that has a good relationship with the IRS and state tax authorities and experience defending claims. It’s also a good sign if the team defending the credit is the same team that did the project. You might also want to take into consideration how long the firm has been in business—sometimes a large audit can sink a small service provider. That said, large firms could mean higher audit fees.
There are several fee structures used, and some can be more beneficial to you as a client. Here, we outline the most common ones as well as potential pitfalls.
A contingent fee is when a price is contingent on the provider’s achievement of a specific outcome for a client, such as obtaining a certain amount in tax refunds.
Circular 230, the set of IRS rules that govern what CPAs, attorneys, and other providers of tax advice must—and must not—do, prohibits tax preparers from performing R&D tax credit engagements under a contingency fee arrangement. To get around this, however, some providers cap their fee based on calculated or anticipated credits rather than actual credits received. The hourly rates associated with this fee structure are generally high when compared with those of other providers.
Impact on Clients
The result is less work performed at a higher cost per hour. Even though this fee structure may provide IRS exam support once the cap is reached, no amount of the fee will be refunded if the credit ends up being disallowed by the IRS during examination or is otherwise unusable.
By contrast, many firms will provide R&D tax credit services on a fixed-fee basis. This cost structure generally involves the provider creating a specific project plan customized to your individual needs. The total fees are generally lower than those based on a percentage of the credit. If a company is selected for IRS examination, exam support is generally charged as a separate fee.
Whatever the fee structure, it’s always important to understand the scope of services from potential service providers before choosing the fixed fee proposal.
Time and Materials
Firms might also provide a time and materials (T&M) fee structure, which charges its fees based solely on the time and costs incurred to complete the R&D tax credit analysis. While this might appear ideal, it’s important to consider that inefficiencies or lack of knowledge with research tax credits could result in significant fees incurred and passed onto you, the client.
T&M Not to Exceed Clause
Time and materials with a not to exceed clause can help ensure that fees are capped. However, it’s important to have the scope of work clearly defined to avoid the possibility of a service provider cutting corners so as not to exceed that fee cap.
Due diligence is a term most often heard in the context of a merger or acquisition, but it’s a concept that’s equally relevant when choosing an R&D tax credit service provider.
Given the significant cost-saving opportunity via the credit, it’s tempting for businesses to select the first provider that sounds good—but it’s critical to choose carefully and confidently. This includes asking tough questions, such as, does the provider:
- Have sufficient experience performing R&D credit studies and a good reputation?
- Have staff who understand your particular industry and how the tax code applies?
- Have tax-experienced professionals, such as CPAs, attorneys, enrolled agents, and engineers, on staff who specialize in R&D tax?
- Make a commitment to follow through and stand behind the R&D claim in the event of an IRS or state exam and any subsequent appeals?
- Have a documented approach that includes spending time interviewing company staff and management?
- Charge fees in accordance with Circular 230, or try to circumvent compliance and charge a percentage of the credits calculated?
The more detailed the due diligence performed on a provider, the less risk there is to a business down the road—and the greater the chance to successfully claim the R&D tax credit.
We’re Here to Help
To learn more about the credit and whether your business qualifies, contact your Moss Adams professional.