The Virtual CPA Success Show: Episode 29

We are joined by Jody Grunden and Dave Danic by special request. One of the most common questions we get from our clients is the R&D tax credits. This credit exists to incentivize American companies to create USA jobs.

In this episode, we are talking about what that means and what you need to do in order to qualify for it.

Jamie Nau: Welcome to today's podcast. Once again Jody and I are joined by everybody's favorite tax person, Dave Danic. So by special request, people heard him on this podcast and sad we want more of Dave. So we had to search deep and wide for a new topic for us. One of the most common questions we get from our clients is about the R&D tax credit, especially for digital agencies, because obviously they're doing a lot of R&D work and there are some important things they need to track and keep an eye on. So I always bring Dave in to those calls. In fact, we have one tomorrow with a client. So this will be fresh in my mind. I'll be really thinking through how to ask questions for that client during this podcast. So welcome to the podcast, Dave. You want to start off with just kind of an overview of what the R&D tax credit is?

Dave Danic: Sure. Thanks again for having me. It's good to be back. So the R&D tax credit is not new. It's been around for about 30 years. The reason that Congress put it into the tax code was because they wanted US companies to hire domestic people, i.e. create US jobs to create new technologies. And really, it was just a mode for Congress to incentivize companies to be competitive in the global economy. So, of course, they don't put in laws that help other countries. So that's why I made that distinguishing factor of saying it's a US company creating US jobs. So I'll go through a couple elements of what that means and what qualifies and feel free to ask questions along the way. So in that sense, there's a four part test that every research project needs to eclipse to be able to qualify for it. I'll go through those first. One is the elimination of an uncertainty. So this is, your project that you're undergoing needs to have an element of uncertainty at the beginning of the project. So for instance, if you're sitting around a boardroom table saying we want to do this project, and you say to developer A, go do this and developer A just goes off and does that. He doesn't really have to ask any questions, then there's really no technological uncertainty. But if you get this blank stare back from developer A, who says, I have never done this before. I have no idea what this means. Then that should be your first cue to say, let's have some research to it.

Jamie Nau: So can you give a couple of examples of ones you've seen that might have qualified for that uncertainty?

Dave Danic: So the one example that we used to see a lot of, and I still think it applies, is like building into a website, collecting payments online. That hasn't been necessarily a new technology. However, if the developer creates a new way of accepting payments online and has to try different things to be able to build this into the website, then that may qualify. And that kind of leads me to the next criteria, which is a qualified purpose of your project. So that means it can be a new product, process, or increased functionality performance. So in essence, paying online is not new. However, if you come up with a better way of collecting payments online, that can qualify for the use of credit. And the third area, the third criteria is the process of experimentation. So whenever you have your team working on research projects, you need to be able to document that there was a process of experimentation. If there wasn't. Again, they're just doing their jobs. So what I tell our clients is like, you know, be sure to take good notes, you know, good time tracking, and time tracking detail of saying this is what I was working on for this certain project, because that kind of helps show a history of what you were trying different things.

Jamie Nau: I know Dave, you and I have worked through a couple of these together now. And what I've really learned from working with you on these, and this is actually why we're meeting with my client tomorrow, is it's better to think about this ahead of time than after the fact. Again, it's not impossible to think about after the fact, but if you have anything that you think might qualify, it's better to talk about it ahead of time to make sure you do qualify and that you’re doing all the documentation that we need.

Dave Danic: Absolutely. So this really has to be a pervasive process for the management team on the research credit. It's hard at the front end because you're either trying just to help a client out, or you're trying to meet a deadline. But it's so much easier when you have your team moving in the same direction, and you've got your time tracking system set up to code things as R&D time, or at least if it's from a project perspective, we can just pull up project A B C and see what the teams hours were on that. So absolutely, you can go back and build out the data. That's super hard, right? I mean, going back a couple of years even to say okay, was this a research project? How much time did I really spend on this?

Jody Grunden: So Dave you mentioned, kind of circling back, you mentioned this is for US based companies hiring US based employees or contractors. Correct? What about for those companies that maybe they're a Canadian based company, but they have a US based operation? How does that work?

Dave Danic: I would say hopefully that Canadian company has a US subsidiary that pays tax at the US level. Then with that information, I would assume it would qualify for the credit. In essence, you're paying US taxes in the credit offsets taxes that you would be paying to the US government.

Jody Grunden: So if they have a company that's based in the US, even though the owners may live in Canada or another country, they would then qualify for the credit for the US based activities.

Dave Danic: Yeah, it's a great question. There's always some angles. Most subsidiaries are C-corporations that pay tax at the entity level. So they're really not looking through on the shareholders there. Even if it would be a foreign shareholder. And I keep saying domestic, so what's that mean? So if you're hiring foreign contractors to do your work, those dollars that you spend for the foreign contractors to work on this R&D project would be excluded.

Jamie Nau: What about any other exclusions that we need to be thinking about? I know a lot of companies listening to this probably have projects done in the past or are thinking about future projects. I just want to make sure that there's no other exclusions that they need to make sure that they aren't including in that.

Dave Danic: One of the biggest hurdles we see is the discussion of funded research. What that mean is that if the work that you're doing is paid for by a client. So you can't get paid and claim the credit. That is double dipping. So that's not necessarily a full blocker, but if it's a time and material job, that means you really didn't have any economic risk in this project. You just kept getting paid. Send the bill, great. So time and material projects are hard to qualify. But if it's a fixed fee project, you want to look at your contracts to see who retains the right to the technology. That's something that you can actually start on the front end of protecting. If I own the technology that I'm doing the work for, then even if I got paid for it and its fixed fee, I still have the technology.

Jody Grunden: So basically, if I develop the platform, or I develop what's being used to create the website, or create whatever the end product is, even though the customer is actually paying for that software, because I developed the technology that's being used for, as long as they have the rights technology and can use it again, you're saying that would qualify then?

David Danic: Yeah, that's a great feather in your cap for saying that, you know, that I was the one that bore the risk to create this technology.

Jamie Nau: Does that apply to only certain elements of the project? Like if a client comes to you and says, we need this awesome website and you're able to do A, B, C and D, but E you’ve never done before and you're going to have to develop, and hopefully it is something you can use for future clients. But does it work for just single elements of a whole project as well?

Dave Danic: I think you could break it out into single elements. So the research credit is broken out into what's your activity that you're working on. So I guess you could have different activities under a certain client project.

Jamie Nau: And that's where the time tracking comes in a lot of the time. So they have project A and they're just keeping all their time in there and it's really hard to break out, you know, going back to your example of they're making us at a payment element to this website that we're developing and we've done that before, and it's special. You want to make sure you track those hours separately so you can apply for this credit.

Jody Grunden: So what happens with the companies that their policies don’t track time? How do you get around that?

Dave Danic: It doesn't make me feel less comfortable, but there have been some court cases where the IRS allowed, or the courts allowed, to take time surveys and do interviews of staff of saying, this is what your time was working on. And you can bring in different elements of support, such as emails, blog posts of what they were working on just to prove that they were actually working.

Jody Grunden: So it can be done it is just going to be harder to come up with the amount of time?

Dave Danic: Yeah, it's certainly not as precise of a calculation. When you lose that level of preciseness, it's harder to defend.

Jamie Nau: I think that’s another reason why you want to do it ahead of time, because if you're one of those companies that don't track time, you may say okay, we're doing this project, let's track time for just this one project, or some elements of this project. I think when it comes to any kind of credit, my philosophy has always been the easier, the better. The easier I can get that calculated, the easier it's going to be on us, the easier it's going to be on someone like Dave to go to bat for me when it comes to getting that credit.

Dave Danic: That's right. Yeah, that's right. So the fourth element is technological in nature, and that's the easiest one. Computer science falls under that. So a lot of agencies can fall under that this umbrella.

Jody Grunden: So the technology question on that would is if you develop the program in a can software like an Excel or an Access or something like that, does that qualify? Or do you have to actually build the access and get the access in order to get the credit? Or can you build it into a can program?

Dave Danic: You can build it into a can program. That's kind of back to saying I'm not building a new product, I'm building a new feature, or I'm building a new process that uses existing tools.

Jamie Nau: So let's go a little bit more, unless you have any further thoughts on that. Let's go a little bit more into the planning. I know we talked a lot about the hours and getting that on track. What else should we be thinking about prior to going down this project?

Dave Danic: Yeah, something that I see with agencies a lot. When we think of agencies, you got development and you got design. So a risk that you undertake for research, when I kept talking about economic risk, this is like you're committing dollars to this. It's not necessarily of, will customers like it risk. So what I mean by that is it's not marketing. And when you think about design, that's more aesthetic. So I'm seeing a lot of the credit on the development angle. So if I'm a big design agency, you have to be saying, really where's the inherent technological work that I'm building into it? Not just the design element of will the clients like it, or will the market like this logo that I'm creating for a client?

Jamie Nau: So can you give us a couple more examples of that? I think the logo is a really good example. What other of those design type examples would you find that would not qualify for this?

Dave Danic: Well I mean if you're doing a lot of, like, content development as a part of your contracts, I would say that doesn't apply to it. I would look the underlying software development. That is where I'm seeing the our agencies claim the credit.

Jamie Nau: That makes a lot of sense. Basically what you're saying is anything that is just for client aesthetics, then that's just a cleaner look, that doesn't qualify. It really has to add value and add purpose to the product for delivering.

Jody Grunden: Does it have to be a product that's being sold or can it just be for internal use?

Dave Danic: Internal use does work. So if you're building something for a client that is internal use, that does qualify. There are some more restrictions on what qualifies as internal use software. I think it would be kind of beyond the scope of this podcast. But whether it's for back office support, how it's linking in with other software utilities comes into play on this that qualifies.

Jamie Nau: So if it adds like ease of use, so if you've been doing the same thing over and over again, and it takes you 100 hours on each project when you do this, if you think there's some technology you could develop that would make your that part of the process take only 10 hours in the future, that's something you might be able to qualify for?

Dave Danic: Yeah, exactly. So if the process used to be starting at step A, and the end result was going to step Z, and the way I used to get from A to Z was going from A to D, to T to Z. That was the old way. Now I developed a new process where I go from A to M to Z, I skipped a step. If there was a technological backing for me to get to that new point, then yeah, certainly want to look into it and see if it qualifies.

Jamie Nau: I guess the other question I have and again, this is kind of in the opposite realm, what if it's something that you are developing? And I know this used to be pretty popular several years ago, and I think it's gone away a little bit, but I still know companies are interested in this. What about developing a product? We want to develop a time tracking software that's better than anything that's out there. We want to develop an expense software, or something like that that you're going to want to sell to customers eventually.

Dave Danic: Yeah, that's really where a lot of the research credit developed from is like, hey, hire someone to create a new product that you can sell. So absolutely, it does qualify. Really where it stops, though, is when your product goes to market. In that sense if you're able to make money off the product at a certain time, then it stops the clock on the research.

Jody Grunden: So is that when it's through the beta testing? So they can still go through the beta test and still make a little money on it, but determining whether or not the product's going to do everything it says it's going to do, once they've gone through that stage and saying hey, now we're in the selling stage. Although the product's going to probably be improved forever, that's always going to be the case.

Dave Danic: I mean, the hard line is saying once you create your first invoice for access to this product then you can say okay, it doesn't exist anymore. But that's a key factor, though, because that's a long product lifecycle. You know, that can take years. And okay, fine. We can claim the research credit on this for building this over three years. And it's not just the developers time too. If Jamie is the CEO of the company and he's sitting in product update meetings for over the past 18 months, a part of the CEO's time can qualify for research. If there's staff people that really aren't that integral to the product, if they're helping bring along the product or test things internally, their time qualifies for it. So we've seen credits where there's 32 people actually claiming time towards this credit, even though there's only like one or two point people on the development team that are that are claiming.

Jody Grunden: I think that is a really good point and probably overseen or often not forgotten.

Jamie Nau: I think that's part of it again, when Dave and I meet with our client tomorrow, that's the stuff that I want him to outline for them. That basically these are the things you need to think about. Don't just track developers time, track your time. How many minutes you are sitting in this meeting with people, and everybody else that's actually involved in this process. Track all of that time. That's the key there. I think going back to your previous point of, you know, especially when it comes to selling the product. It might make you rethink when you're going to send that first invoice. If the product's not quite ready yet and you still have several hours into it, but you can start selling it, maybe you have to rethink that because it may lose you thousands of dollars in credits. Those are things you need to think about ahead of time. Like, when are we going to pull that trigger on the first invoice? Understanding that criteria is key.

Dave Danic: Very good point. Then the follow up question to that is always okay, if we're in the software space, you don't just create one product and then it's over. No, you're always maintaining the software, you're providing updates and things like that. Does research qualify for that? Yes, but you really have to make sure that what you're working on is a new product, or process offshoot of that original product. Just regular maintenance starts getting a little hairy there.

Jamie Nau: So I think the big things here is what I like to see is there's a plan documented again, all this stuff documented somewhere so that the CEO knows it. But not only the CEO, but the other people working within the agency know this because you want to capture every cost you can. So I like to see the plan documented, those timelines identified. Who needs to be aware of that? Has it been communicated to them? So that's a lot of the stuff that I like to see prior to starting. Anything I missed in that area in terms of like what you need to do to prep prior to starting a project?

Dave Danic: Bring in the CTO, or head of development early on in the process. What I have found is that no one wants to admit that they don't know something. This is not a pride issue. This is a money issue. You know, so like if we can claim a research credit for something that you're working on, it's okay to say hey, this an unknown for me to work on. So put the pride aside and say hey, no, let's see if this qualifies for the research credit. Half the time I'm talking, like I'm not talking to the finance people when we're claiming the R&D credit. I'm talking to the developer, and the engineers, and I have no idea what they're talking about. I'm a tax accountant. However, I'm just asking broad questions of saying, what did you not know? Tell me what routes you tried to take to prove that we experimented here, because they're going to throw out code lingo. And I'm like, I don't know.

All: Laughing [in audible]

Jody Grunden: Question I’ve got Dave. It sounds like you've got it down pretty well with what qualifies. For those that don't have somebody in their corner like you, how do they find somebody with that R&D credit experience? What should the process be?

Dave Danic: Well, one ask the question and just say, you know, historically it's been like, oh, it's manufacturing. I built this new product or I built this new machine. I think just being a little being a little more aggressive in asking your current tax accountant if they have any ideas, if they've ever claimed the R&D credit in the past. Can we discuss some of the things that I'm working on? And if they think that you would qualify? You know, we've partnered with some third parties that only do R&D credits. If we feel that they're sizable, they have more attorneys that can read contracts back to that fixed fee contract. They have more experience at reviewing some of the provisions to see if that would qualify. So tell them, you know, certainly feel free to bring in another company that might help out. Then they send the report to your tax accountant to claim the credit.

Jody Grunden: So the tax accountant is the first step, but that's not all. They can reach out to other companies out there to help out.

Dave Danic: Yeah, if you're getting a negative response there and you feel that you do have some qualified research expenses and certainly reach out to a third party that just does R&D credits.

Jody Grunden: How does a third party typically get paid? Is that going to cost a couple hundred bucks? How does that work?

Dave Danic: It's usually no fee until they identify credits for you. So and it's usually a percentage of the credit that they claim for you. It is usually up to 35 percent. So that's actually a good question. Like what's in it for me? The credit can range depending on what you filed in the past, somewhere between 8 to 14 percent of your qualified research expenses. So you had one hundred thousand dollars of qualified research expenses, your tax credit, which is a one for one off your taxes, let's say it would be ten thousand bucks, that's 10 percent. But if you're a bigger agency and I've got a million dollars of expenses, you can see how these numbers can jump and you can go back three years to claim credit. So you can go back. Your tax account's not going to like you because they have to amend some tax returns. But if you had one hundred thousand per year, now we're talking thirty thousand dollars, you start talking some real money.

Jamie Nau: So you said three years. Do you mean like three years from the return, or three years from today's date? Like, how does that timing work?

Dave Danic: So it's three years from the date that the return had to be filed. For example, my 2017 tax return was due April 15th 2018. So now I have to file my amended return for 2017 by April of 2021. So really you're looking at 2017 and forward now. Jump on it now if you're listening and you say oh I recall you ask the question now don't wait until March of 2021 because by the time you get all the data around you're really pushing the deadline.

Jody Grunden: So just kind of curious, without identifying the client, what's the biggest credit that we've seen so far?

Dave Danic: Right now from an agency perspective, we've seen ones that are upwards of like three hundred thousand dollars, and that's a multi-year credit.

Jamie Nau: And when you mentioned earlier, one for one, what you mean by that, just make sure I'm clear on it, is that if your taxes were one hundred thousand dollars in that year and you get a ten thousand dollar credit now, your taxes are only ninety thousand.

Dave Danic: Yep, that's exactly right.

Jamie Nau: So three hundred thousand dollars is pretty in your pocket.

Dave Danic: And this wasn't necessarily a huge agency, I don't know, maybe 20 or 30 people, but it was just the nature of the work they were doing which fell under the research credit. So yeah it was really cool to see.

Jamie Nau: So I'm going to throw our email address out there real quick. So obviously I knew that Dave is a big hit, which is why we brought him on here again, based on some of the emails we were getting. So I'd love to hear more feedback from our listeners. So if you have any feedback for us, any questions, if you want to be a guest, please email us at: vcfo@summitcpa.net So Dave, we are running a little close on time here. Any final thoughts for our listeners? Again, I know this is a big topic and bringing a professional in is really important, but anything that they can get out of this podcast, in the last minute or two here that you want to throw their way?

Dave Danic: I think this applies to more agencies than not. If you don't ask, you're not going to receive. So it's certainly worth the question.

Jamie Nau: I think that’s a great point. Ever since you and I first talked about this, I've brought it up with almost every agency I've worked with personally. I know our other CFOs are doing the same. So I think that's a great point. What about you, Jody? Any final thoughts for our listeners?

Jody Grunden: Yeah I mean, research and development credit has been around forever. So it's one of those things that a lot of people don't know about it. Some people are hearing about it for the very first time. But like Dave said, you can go back and read your last two years of tax returns to help out. That's still a big chunk of money, maybe not 10 years they've been in business, but at least the last three years can really help the bottom line, especially in today's world where money is at a premium. We want to make sure that we take advantage of every possible thing. And Dave mentioned the R&D is a federal tax credit. States also have similar credits that you can actually tap into. So that client may have gotten three hundred thousand dollars in federal, maybe another hundred thousand in state. Who knows? But that's key. And not all states you can go back three years. So that's important to know. Also, your state may be a two year look back or one year look back or maybe no look back at all. So it is a state by state thing. So I'd make sure that you talk to the tax accountant and if your tax accountant is not aware of it or doesn't know about it, reach out to a company that does have that experience. You're going to find that little research and the time you put into can really develop into a lot of money for you.

Jamie Nau: Yes, definitely. So I would say anyone that's listening to this podcast, the least things you should do is think back to 2017, 2018, 2019, pull up some time reports. What were you working on? What were the things that you were doing that might qualify for this? That's the first step. And then I think the second step would be, what's your business plan? What are the things you're thinking about doing over the next year that might qualify for this? And if either of those bring up any questions for you, contact someone, ask your accountant. That's the first step that you can do for sure for anyone listening. So definitely appreciate Dave and Jody coming on and throwing all this knowledge out there. I know I learned a couple of things, so I appreciate you guys. Thanks.

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Episode 29 - R&D Tax Credit 👉 https://ctt.ec/5k6RG+

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