Encoursa Webinar: How Government Contractors Qualify for the R&D Tax Credit
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This document summarizes a webinar about how government contracts can qualify for the Research and Development tax credit. It discusses that government contracts are often overlooked as eligible expenses but can qualify if they meet certain criteria. Specifically, contracts must involve technological uncertainty and experimentation through a qualified research process. Additionally, the company must retain intellectual property rights and bear some financial risk in the research for the contract to qualify rather than be considered "funded research". Different types of government contracts have varying likelihood of qualifying based on these criteria.
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Encoursa Webinar: How Government Contractors Qualify for the R&D Tax Credit
- 1. HOW GOVERNMENT CONTRACTS QUALIFY FOR THE R&D TAX CREDIT Presented Left Brain Professionals and Hull & Knarr
- 2. Host: Liz Briggson, CPA Connect on LinkedIn: https://www.linkedin.com/in/lizbriggso cpa/ Welcome to Encoursa! To get the most out of this presentation: Utilize the GoToWebinar ‘Questions’ pane for live interaction Download the hand-outs Respond to the polling questions If you qualified for CPE credit, your certificate will be available for you to download from your Encoursa dashboard one hour after the conclusion of the event For any questions about today’s webinar, please contact Encoursa via email at: support@encoursa.com
- 3. GOVERNMENT CONTRACTS & ACCOUNTING EXPERT Email: robert@leftbrainpro.com Phone: (614) 556-4415 LinkedIn: https://www.linkedin.com/in/rjones330/ Website: www.leftbrainpro.com/ Robert Jones CPA, CPCM, NCMA Fellow Professional Background Masters in Accountancy – College of Charleston Business Management , Compliance, Operations Controller Defense Contracts Manager Instructor and Speaker
- 4. How Government Contracts Qualify for the R&D Tax Credit Oct. 20, 2020
- 5. LEARNING OBJECTIVES: TODAY’S PRESENTERS: Carlos Freitas Partner Hull & Knarr LLP cfreitas@hullandknarr.com (317) 889-2134 Robert Jones President & Principal Left Brain Professionals Robert@leftbrainpro.com (614) 556-4415 X101 • Describe R&D Tax Credits • Define includable expenses • List the criteria to qualify for R&D Tax Credits • Describe the impact of contract type
- 6. Employs Engineering Approach led by degreed engineers Who is Specializes in R&D Tax Credits and other local incentives Can work directly with a company, with accountants or accounting firms, VC firms or other strategic advisors NOT an accounting firm “The continuity H&K provides has enabled us to benefit from the R&E credit in a painless manner, in large part thanks to the relationships they have developed with our engineers.“ ― Tiffany Pace Controller “Working with H&K has had a positive impact on our business. We get to focus on running our business while H&K works hard to maximize our R&D tax credits.“ “H&K’s knowledge of the SBIR program and governmental structures helped us realize credits we would have otherwise forfeited; and they’re helping us maximize our credit potential for the future.“ ― Lisa Ferris COO ― Chris Ludlow VP of Engineering
- 7. Who is A boutique accounting firm specializing in government contract accounting. A small business dedicated to helping other small businesses. We provide solutions that address inadequacies or noncompliance and bring about change to help your company grow and prosper. Our practice areas include accounting system design and implementation, audit support, accounting support services, and training.
- 8. (I ho communication Hull & Knarr Left Brain Professionals Accounting Firm External CPA Govt Contractor (CFO/VP Finance/Controller)
- 9. What do you believe is the main reason why most providers don’t feel comfortable including government contracts in the R&D credit calculation? a. Didn’t know they could be included. b. Tax code states, “funded research is excluded”. c. Was told they couldn’t be included and never looked into it. d. It’s too complicated. Question
- 11. 30+ YEARS WHAT IS THE R&D CREDIT? WHAT DOES IT MEAN FOR A COMPANY? Tax Credits FINANCIAL REWARD 30+ YEARS OFFSETS INCOME OR PAYROLL TAX Govt Awards IR&D TAX LIABILITY CASH FLOW
- 12. INDICATORS OF QUALIFIED RESEARCH: Qualification for the R&D Credit depends on many factors. Typical indicators of qualified research activities includes: Awarded government R&D projects from: SBIR, STTR, OTA, etc. Manufactures products with a highly automated process Develops software using new algorithms, techniques or architectures Degreed engineers or scientists on staff Patentable products or production methods
- 13. Which is an indicator of qualified research activities? a. Degreed engineers or scientists on staff. b. Patentable products or production methods. c. Manufactures products with a highly automated process. d. All the above. Question
- 15. SUBS AND CONSULTANTSMATERIALSWAGES Qualified Generally the largest component of eligible R&D expenses. Wages can be for direct R&D, direct supervision of R&D, or direct support of R&D: Principal Investigators Engineers Managers with technical input Technicians Production/Assembly personnel Materials used in the R&D process can be a significant contributor to the Credit: Prototypes, including experimental deliverables if first of a generation Materials used in Process development Pilot Runs Software used in R&D Commonly used to temporarily add capacity and complement internal capabilities. Includable at 65% of incurred costs: Testing services Outsourced R&D Software development
- 16. Qualified R&D Expenses include all the following except- a. Wages b. Facilities c. Materials d. Subs and Consultants Question
- 18. Criteria for FINANCIAL RISK Does the contract state that payments are contingent upon success? Payment upon milestones or other deliverables Payment is not on a reimbursement basis FOUR-PART TEST Congress established a four-part test that defines qualified research activities associated with new and improved product and process development to exclude routine engineering : Technological in Nature Technological Uncertainty Process of Experimentation Permitted Purpose RIGHTS Does the contract state that AT LEAST some of the intellectual property is retained? The SBIR/STTR program is designed in a way that allows for companies to retain some of the IP.
- 19. Treasury Regulation §1.41-4A(d) – (3) Research in which the taxpayer retains substantial rights – (i)In general. …A taxpayer does not retain substantial rights in the research if the taxpayer must pay for the right to use the results of the research… CASE LAW Treasury Regulation §1.41-4A(d) – (1) In general. Research does not constitute qualified research to the extent it is funded by any grant, contract, or otherwise by another person (including any governmental entity)… Amounts payable under any agreement that are contingent on the success of the research and thus considered to be paid for the product or result of the research are not treated as funding… Treasury Regulation §1.41-4A(d) – (2) Research in which taxpayer retains no rights. If a taxpayer … retains no substantial rights in research under the agreement providing for the research, the research is treated as fully funded… Treasury Regulation §1.41-4A(d) – (3) Research in which the taxpayer retains substantial rights – (i)In general. …A taxpayer does not retain substantial rights in the research if the taxpayer must pay for the right to use the results of the research… The regulations under IRC section 1.41-4(c) include the excluded activities for qualified research. Per 1.41-4(c)(9) – Research Funded – Qualified research does not include any research to the extent funded by any grant, contract, or otherwise by another person (or government entity).
- 20. Fairchild Case Lockheed Martin Case CASE LAW KEY TAKEAWAY: Funded Research is only excluded if a company both gives away the IP and gets paid even if they don’t successfully meet the milestones (for example a LoE type of contract). Otherwise, includability comes down to Right Retention and Financial Risk. Fairchild Industries, Inc. v US (US Court of Appeals, 1995) The court held that whether research is funded depends on “who bears the research costs upon failure, not on whether the researcher is likely to succeed in performing the project”. Lockheed Martin v US (Fed. Cir., 2000) The government argued that a taxpayer only retains substantial rights if the taxpayer retains the right to exclude others from its research and in which other parties do not also have the right to use or disclose the taxpayer’s research. The court of appeals held that the right to use the research without paying the customer, even if not an exclusive right, is a substantial right. Therefore, the research credits were allowed because research was not funded.
- 21. Includability comes down to- a. Right Retention b. Financial Risk c. Who pays for the work d. Both A & B Question
- 23. EXCLUSION FOR FUNDED RESEARCH: In practice, contract types can indicate how likely they are to qualify: T&M FFP (LOE) CPFF/IF/AF Commercial Unbilled Direct FFP IR&D B&P Overruns Low Medium High
- 24. Some contract types are more likely to qualify for R&D credit than others? a. True b. False Question
- 25. CORPORATE OFFICE 300 S. Madison Ave., Suite 300 Greenwood, IN 46142 Phone: 317.889.8494 www.hullandknarr.com Left Brain Professionals Inc. @LeftBrainPro @LeftBrainPro Left Brain Pro LeftBrainPro www.LeftBrainPro.com Support@LeftBrainPro.com (614) 556-4415
- 26. Thanks for attending today’s event! Encoursa is committed to helping accounting and finance professionals develop personally and professionally through continuing education. Join us for Left Brain Professionals’ next event on November 10th: GovCon Job Costing Self-Study Courses by Robert Jones: Find us here! https://encoursa.com/ https://www.linkedin.com/company/e ncoursa/ Please take the course survey following the program. You can log in to your Encoursa user account to access your CPE certificate, the recording, and materials. Laying the Foundation for GovCon Accounting Fundamentals of Indirect Rates Advanced Indirect Rates
Notas del editor
- National Contract Management Association
- Many misconceptions associated with the research tax credit prevent companies from maximizing their benefit. One of the biggest misconceptions is government contracts do not qualify for the research tax credit
- IMPROVE CASH FLOW Recoup funds from previous research programs to fuel new initiatives, reduce estimated tax payments, and minimize the amount of cash leaving your business each quarter. STAY FOCUSED ON R&D Your technical team should not spend time determining which of their activities are qualified. We will quickly make those determinations so you can stay focused on making advancements in your field. REDUCE EXPOSURE Keeping your business innovative and ahead of the competition requires considerable investment. Smart companies use proven experts to recover these expenses and protect their claims. ENGINEERING APPROACH: Understand R&D processes Accurately qualify R&D activities Minimize time spent by clients qualifying R&D Obtain documentation to substantiate claims Maximize the footprint of qualified R&D activities Bolster defense of R&D Credits before the IRS
- Hull & Knarr and Left Brain Professionals are strategic advisors specializing in the R&D credit and government contract accounting. Government contracting is complex and we provide peace of mind and compliance for our government contractor clients while allowing their CPA firm and accountants to focus on what they do best.
- Federal and State financial reward for companies that create or improve its: Products Technology & Techniques Manufacturing Processes Software Amounts to approximately 12% of eligible R&D expenses incurred each year Tax Credit is a dollar-for-dollar offset of tax (better return than a tax deduction) Unused credits may used in the future for up to 20 years For businesses within their first 5 years of revenue, the credits apply to payroll taxes What does it mean for a company Costs associated with Government contracts also qualify. Based on: IRS Regulations – Treasury Regulation §1.41-4A Court Cases – Lockheed Martin v. US and Fairchild Industries v. US The R&D Credit is a specialized part of the tax code that is rooted in engineering While the calculation is filed on a tax form, engineers can speak the same language as technical staff to determine whether activities meet the necessary criteria for qualification. This leads to ability to qualify more activities with certainty, translating into a higher credit, which reduces tax liability and increases cash flow
- Operate in a manufacturing industry – electronics and components, chemicals, specialty materials, etc. Operates in industry where prototyping is common: Medical Aerospace Robotics Defense Applications APIs Embedded software Cloud computing Cyber security Large, custom ERP implementations/development
- d. All the above
- B. Facilities
- One of the most common misconceptions within the R&D Credit is the concept that most believe government contracts aren’t includable in the credit calculation. The reason for this is … While this does not itself provide a definition for funded research, the following Treasury Regulations (official IRS guidance) provide clarification on identifying critical contract characteristics.
- Given these regulations, the critical contract characteristics become rights retention clauses and payments contingent upon success. Fairchild Industries, Inc. v US (US Court of Appeals, 1995) Funded Issues: Financial Risk The appellate court held that research credits were eligible because research was not funded – the total system responsibility was on Fairchild to produce aircraft that met its customer’s requirements for a fixed price. The lower court argued that because progress payments were made to Fairchild before a working product was delivered, the research was funded to the extent it received payment under the contract. The Court of Appeals reversed that decision, determining that the progress payments from the government to Fairchild did not alter the provisions of the contract that put Fairchild at risk for the development. The fact that the taxpayer received advanced payments from the Air Force did not change the result because the payments were refundable if the project was not successful. The court held that whether research is funded depends on “who bears the research costs upon failure, not on whether the researcher is likely to succeed in performing the project”. Lockheed Martin v US (Fed. Cir., 2000) Funded Issues: Substantial Rights The government argued that a taxpayer only retains substantial rights if the taxpayer retains the right to exclude others from its research and in which other parties do not also have the right to use or disclose the taxpayer’s research. The court of appeals held that the right to use the research without paying the customer, even if not an exclusive right, is a substantial right. Therefore, the research credits were allowed because research was not funded.
- D. Both A & B
- A. True