How does R&D tax credit consulting work?

The R&D Credit is a great idea for companies that do technological work in the USA. The tax credit is offered by the US government to entice firms to do technological work, here in the US and there are many states that “piggy back” on the IRS’s R&D regulations by having their own state R&D tax credit.  Searching for the term R&D tax credit on Google will bring up loads of accounting firms who will gladly “write up” a research credit study for your firm (the taxpayer), for a good fee. But most of them have ‘zero engineers’ on staff. This can be an issue since the R&D tax credit is based on technology, and if the credit is audited by the IRS, this can be a problem.

Besides the problem in the US of a shortage of Accountants who also happen to be Engineers, the timing of creating an R&D Study is another major issue when hiring a non technological, ‘generic’ R&D tax study developer. The work of creating an R&D tax credit study is usually subcontracted out to a specialist. R&D tax credit consultants almost always require a taxpayer to sign a contract for delivery of the tax credit study. The price of the study is usually a certain percentage of the final credit.  This leads to these accounting firms subjectively trying to get the largest credit possible for your firm, and therefore, the largest fee for themselves.

Sounds great, right? While getting a larger tax reduction from the IRS is often admirable and is great for the R&D tax credit consultant, it often doesn’t work out well for the taxpayer.  Extreme aggression in filing for the R&D tax credit is a red flag for the IRS. The cost of hiring the R&D tax credit consulting firm to create an effective R&D tax credit study is only half of your firm’s cost. Paying the R&D tax credit consultant to defend a tax credit study that they created can double your costs.  An aggressive R&D tax credit can open the rest of you tax return to scrutiny too. For this reason it is doubly important that you can trust the honesty and accuracy of the firm doing your R&D tax credit.

An additional issue is the timing of the development of the study. Most R&D tax credit consulting firms will try to “bunch up” tax years. The period of time when amendments can be made to IRS form 6765 for the  R&D tax credit is subject to the US Treasury’s statue of limitations, which is 3 years from the original filing date. Most R&D tax credit consulting firms also want to file an amendment, known as ‘a claim’ for past years, but this is for their benefit, not yours.  It basically allows their charge for the R&D study to be increased.  High tech employment being what it is, in 3 years most of the employees who did the R&D work will have already left for other career opportunities. This makes is hard to document the research that was performed (a requirement of the tax law) by these employees. This causes a problem for both the R&D tax credit consultant and for the IRS. And trouble for the IRS usually leads to more scrutiny of your tax return, which is actually the opposite of what you desire. Moreover, filing an R&D tax credit ‘claim’ requires a ‘specificity report’ that lists your business components. If your R&D tax credit developer doesn’t know what this report is, you are advised to keep looking for a consultant.

A better way to document the research performed by your firm is to do it at the same time that the R&D  is occurring. This allows you the luxury of creating contemporaneous substantiation that will be needed later. We suggest that you have your R&D tax credit consultant create a study for each tax year during the year that the research is being performed.  Waiting a few years and hoping that you have created the correct proof (substantiation) needed for the credit is taking a chance that makes little sense.

A better idea is to hire an experienced, qualified third party who will work closely with your tax department to create the R&D tax credit study and share it with your accounting department. This way, if your firm’s tax  return gets audited, you already have the proper documentation.

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