Tax planning tips: Helping clients claim the R&D tax credit

For small practitioners, providing advanced (specialty) tax services such as claiming the Research & Development (R&D) tax credit for clients can be challenging and intimidating. Providing traditional tax planning services requires identifying the opportunity, determining a strategy, and executing it. However, this process is more complex with the R&D credit. We must first determine whether a client’s R&D activities qualify (not all research activities meet the IRS rules), document those activities diligently, and perform a complicated credit calculation.

The R&D tax credit is a significant tax savings opportunity for eligible clients, often returning about 10 percent of engineering payroll and R&D-related expenses for clients who qualify. The result presents an enormous opportunity for small practitioners to drive significant value to their clients in the form of tax savings.

The five general steps in an R&D study include the following:

1. Identify and collect activity data related to R&D projects (business components). 
2. Gather payroll, contractor payments, and supplies expenses.
3. Walk clients through qualification rules and have them describe their R&D processes.
4. Create/compile documentation of Qualified Research Activities (QRAs) and Qualified Research Expenses (QREs)
5. Review R&D study with clients and finalize documentation.

Due to potential audit risk and the complexity of the IRS rules for what qualifies, many firms previously outsourced client work related to R&D tax opportunities to expensive specialist firms. Even when outsourcing, the tax practitioner still needs to understand the R&D credit qualification rules, related terminology as defined by the IRS and how it applies to the client’s specific industry, and the credit calculations.

Our risk is not completely eliminated solely because the third-party company is performing the study. We still must understand enough to help translate to the client the purpose for the R&D study, their resulting savings in the current tax year, the audit risk related to the position taken, and the possible negative financial consequences if their R&D credit undergoes scrutiny. For example, the scrutiny could be part of a future IRS audit and cannot be properly supported. If this occurs, the client would have to pay back the credit, plus penalties and interest.

Not all third parties are alike. In May 2022, the FBI raided the alliantgroup’s Houston headquarters. The alliantgroup is a major player in the outsourced R&D tax credit services market, among other specialty tax services. Therefore, it is particularly important for practitioners to do their due diligence not only on the R&D credit, but on third-party providers and software vendors. There are many excellent partners that will help small practitioners obtain knowledge and training to give us the skill and confidence to identify R&D tax credit opportunities, communicate those to the client, and execute the R&D study.  

With the rapid growth of cloud-based software tools for accountants, it was only a matter of time until R&D tax credit automation software became available for accountants who want to provide their own R&D services instead of outsourcing to third parties. For example, RetroacDev’s R&D Tax Credit automation software enables any firm to perform their own R&D study by using a combination of artificial intelligence (AI), data analytics, and a client’s existing project-tracking data. RetroacDev sorts through existing task-level data from popular project management tools—GitHib, Jira, Asana, and others—to determine each employee’s time breakdown, and uses AI and rules to classify those tasks into QRAs vs. non-qualified activities.

The platform also provides electronic surveys modeled after the IRS Audit Guidelines to help accountants and clients understand the rules. Clients complete the survey to help determine which projects are eligible for the credit. After uploading payroll, contractor, and other R&D-related expenses, the software calculates the client’s QREs for the tax year. Finally, the accountant and client review the Qualified R&D time for each employee, survey responses, the QRE calculation, and the R&D documentation before finalizing the study.

In many ways, this is an ideal way of providing R&D services because the client is being educated on the IRS rules, while providing the same R&D information had the study been performed by a third party. In addition, using automation software allows practitioners to provide R&D credit services for small businesses that many third-party providers would otherwise not engage with due to their hefty minimum fee requirements.  

Performing R&D studies internally provides significant opportunities for practitioners. It allows us to have more control over fees, risk, and expand our value-add tax services to more clients. In my experience, performing the R&D study internally earned my firm significantly more income with far less of a time commitment than compliance work, while reducing our clients’ costs and giving them a better ROI. My firm currently uses a hybrid approach when providing clients with R&D tax solutions. If the client is in an industry where we have expertise and the credit is in our comfort zone, we perform the R&D study ourselves. We outsource clients outside of these criteria to a third-party partner.

In addition to the R&D credit, there are many other tax planning opportunities for practitioners. Many of which can be found in The Path to Advisory (available for download), and all opportunities will be available in Intuit’s tax advisory planning software, Intuit® Tax Advisor, launching summer 2022. The tax planning software will provide background information on each strategy to help practitioners identify the planning opportunities and additional information via guides, articles, and educational resources related to each strategy.

Editor’s note: In addition to downloading “The Path to Advisory,” access the whitepaper’s Executive Summary for more information.