The Issue
Many times, the source of qualified research expenses (or QREs) for research tax credit studies is found from investigating Profit & Loss (P&L) or GL accounts. This approach works well when the taxpayer follows a strict costing and accounting policy, and where everyone is well educated on the rules of what qualifies under Section 41 for purposes of the Research Tax Credit. Alternatively, this works when the claim is isolated to select cost centers or departments where costs are easily tracked and accounted for.
However, this practice commonly leaves QREs unidentified and uncaptured, resulting in under-claimed Research Tax Credits. On average, we’ve seen up to 40% of missing qualified research expenses, and in some rare cases where the taxpayer doesn’t have robust accounting practices, this figure can be substantially higher.
The Solution – the DST Approach
A more thorough and detailed approach is to start by examining the activities being conducted by the taxpayer, and work down to the expenses incurred from there. The reason why this approach isn’t the industry standard is that it requires subject matter expertise beyond that of accountants and tax professionals. It requires Tax Engineers. Tax Engineers are able to conduct productive peer-to-peer discussions with the technical members of the taxpayer’s team. They ask in-depth questions based on a fulsome understanding of science, engineering, accepted methods and best practices.
So why aren’t all providers doing this?:
- It takes more time. DST’s Tax Engineers come from industry and are efficient in interacting with our taxpayers’ subject matter experts (SMEs).
- It takes science and engineering know-how. DST’s Tax Engineers are all degreed scientists or engineers and have an average of 8 years of working experience in their respective fields. We certainly aren’t experts in your field, but we have a tremendous amount of industry knowledge, which allows us to cut through the background and dig through the activities in an effective manner to drive to the costs.
- It takes teamwork and cross-discipline collaboration. DST follows a three-pronged approach which incorporates our Tax Engineers, Tax Associates and Tax Attorneys together on every client study. This provides fantastic coverage and vision to make sure that the taxpayer’s study is well structured and can be defensible in any event of an examination.
Practical examples
Taxpayers with qualified process improvement research activities, or manufacturing process engineering activities, often times don’t have a separate GL Account listing for materials consumed to build components to be used to run trials (e.g., temporary materials to build soft tooling to feed raw materials into lines, or scrap consumed during material runs for product testing). Additionally, a portion of consumable costs from quality labs for testing of new product or process development would also be qualified. Through discussions that focus on identifying qualified research activities (QRAs), DST Tax Engineers strive to determine if a sample tracking system can be used to quantify the number of R&D samples ran through the lab, so that an accurate and precise QRE value can be attributable and captured towards the credit. Due to the inability for the accounting team to properly record these costs (or the fact that they are simply unaware that they exist), they go uncaptured, and subsequently unclaimed, toward the research tax credit.
More significantly perhaps, is capturing of qualified wages or salaries. Operations or manufacturing salaries would likely be accounted for under direct labor or buried under some other cost of goods sold (COGS) account. Without identifying the QRAs through conversations, these qualified wage amounts can go unidentified and unclaimed.
Final thoughts
Although this approach may sound like a daunting task, it’s an easy undertaking for DST’s experienced team. We do this every day, and our team is trained to do this as naturally as breathing, because this is what we do – we are Tax Engineers. Learn how the DST approach could work for your business by getting in-touch with one of our Tax Experts today!