I knew he had been overpaying…
When I first met one of my clients, a software developer, he was complaining about how much income tax he had been paying. But since the person who had been preparing his taxes wasn’t “just” a CPA—she was a Director on the California Board of Accountancy, the group that basically ensures CPAs know what they’re doing—he assumed his tax returns were accurate.
I took one look at his tax returns and immediately knew he had been overpaying. Why? Because, like so many other CPAs, his former tax preparer hadn’t told him about the Research & Development (R&D) Tax Credit.
What is the R&D Tax Credit?
The R&D Tax Credit is a complex tax incentive designed to encourage development in just about every industry. Instead of simply deducting your R&D costs as business expenses, this program gives you a tax credit equal to 10 to 20% of your eligible R&D costs. Both California and the Federal government have programs, and if your business uses technology in some way to develop, design or improve something, you can usually qualify for both.
As far as I’m concerned, the R&D Tax Credit is one of the best tax credits out there. Why? Because it gets my clients back the most money for things they’re already doing. Plus, for new clients I can usually go back three to four years, amend their tax returns, and make them feel like they hit the jackpot in Vegas.
Why doesn’t every CPA mention the R&D Tax Credit?
Determining exactly what expenses qualify for the R&D Tax Credit, and ensuring you have enough proof to stand up to an audit, is actually quite complicated. Other CPAs shy away because they know that if an incorrect tax return is filed based on the opinion that they gave as a CPA, they can be the ones on the hook for the penalties.
In contrast, we’re experts in this area, and feel confident in our abilities to properly classify and document qualifying R&D expenses for our clients. Our firm has represented multiple high profile cases in R&D tax credits and other government incentive programs for over 10 years.
What makes the R&D Tax Credit so complicated?
There are actually four elements that can get tricky:
- Ensuring you meet the definition of what constitutes R&D – There are three tests that must be met in this area. You need to understand these.
- Quantifying which costs qualify – The R&D costs must have been incurred by someone who was on your payroll, and then only the time spent developing and testing your hypothesis and results count. Breaking this out and quantifying/qualifying everything can be challenging.
- Documenting your qualifying costs – Although documentation isn’t required when you submit your tax return, documenting things is obviously the smart thing to do. We create a unique study that takes all of the information behind the tax credits we’re claiming and packages it up in a way that’s highly likely to stand up to an audit.
- Determining which calculation method to use – There are three different methods of calculating the tax credit itself, and they’re all complicated. You need to work with a CPA who understands these three methods, and knows which to use in any given situation.