Self-Preservation: IRS

"When we quit thinking primarily about ourselves and our own self-preservation, we undergo a truly heroic transformation of consciousness." ~ Joseph Campbell

Defending every claim in tax return is the single most important skill for any tax preparer. This is why many accounting firms outsource the substantiation of R&D Tax Credit claims to firms like mine. But how do you know if the people preparing your taxes are reputable? How do you know they are able to perform what counts most? You don't.

That is why I think the IRS should rate tax preparers according to audit results. Crazy, I think not. I have been bouncing this idea off of people for the better part of a year now and the only objection to it that I hear is that this might create some liability for the IRS. My retort is there are already government agencies that rate companies on some metric. Most notably the Occupational Safety & Health Administration

OSHA publishes the safety ratings of almost any type of company you can think of. And if you think those safety ratings are insignificant you are wrong. Those safety ratings add another metric used to determine contract awards.

I am not going to try and spell out how the rating system would work in this simple blog; but, I think the key is to rate the tax preparer according to a simple scalable rating system on audit results.

If we the taxpayers could see a tax preparer's standing with the IRS, we would be a better educated consumer. This in turn would cause the tax preparers that play "audit lottery" with the IRS to be held more accountable than to just the company that they failed. In turn, fewer taxpayers would use those preparers in poor standing.

With fewer incorrect claims being filed tax revenue would likely increase. The increase in tax return accuracy would allow the government to downsize the number of IRS auditors. This is why I don't think the IRS would suggest such a system, Self-Preservation. Essentially, if there are more bad tax filings then there is more work for the IRS. More work for the IRS means job security. (Maybe this is why the tax code is so confusing to. Joking! sort of)

This is a general theme I see with the government agencies. Always expand rather than contract with improved efficiency. For those of you that think this is crazy or impossible give me your thoughts in the comment section below. Maybe it will ease my frustration or maybe I will light a fire under you to want a similar system. Either way it is progress.

PS

This self preservation theme is seen in other government agencies but there is one other that bothers me recently. The Department of Defense and their contracting officers. I will follow with that in the following days.

You Already Take the R&D Tax Credit

“It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.” ~ Mark Twain

I have been talking to a lot of companies lately that have heard of the Federal R&D Tax Credit and many of them are already taking advantage of it. This is good. We need the companies that are driving technological development to grow by increasing R&D spending. Unfortunately for many of them, they are unaware of deficiencies in the quantification and subsequent substantiation of their R&D credit claims.

Controllers and CFO s tell me, "My accounting firm does that for me." or "We have been doing this for years and we haven't had a problem." These quotes often indicate to me that these people know falsehoods as a fact and it's not their fault. In the past, the R&D tax credit claim could be substantiated by any accountant but it is different now.

My frustrations with these statements have grown lately. I recently did work for one client that had a large regional accounting firm perform an R&D tax credit study and it was crap. The R&D credit study report just regurgitated information provided an individual who did not even have cursory knowledge of the four-part-test. Wages of technical writers, technicians, and management people were erroneously included in the calculation at 100%. No due diligence was performed to validate the company's raw data. Until, I did my work they had no idea how deficient their previous accounting firm had been.

And that is not an extreme case. I have seen firms apply blanket percentages of 5% to all of production and arbitrary number for CEO s that merely listen to R&D meetings. Their mentality is let's go after it all and if we lose 20%, 30%, even >40% in audit the company is still better off. But that is not true. Cash strapped companies can not afford to pay back adjusted claims plus interest and penalties. Staffing and budgeting are adjusted according to estimated tax bills and any adjustment can substantially hurt a company.

But from what I have seen recently, the people that work this way are not looking out for the best interest of their client. They are only looking out for their own interests. Unfortunately the penalty from the IRS gets assigned to the company and not the misleading, narcissist.

To avoid any problems, educate yourself on the R&D tax credit. Use resources like IRS.gov, Wikipedia, and Hull & Knarr. Look for specific IRS directives like the Tier 1 directive, audit guidelines, court cases, and position papers on each service providers website. This is the only way you can be sure what you know for sure is so.

State R&D Tax Credits

I don't have a way to make this topic an interesting read so I will be dry and bland when I write this (not that I am Dave Barry-esque in my other postings). I just want people to know that Hull & Knarr's website now has updated information on every State's R&D tax credit. You can get credit calculation methods, expiration dates, credit carry forward/back periods, limitation, and resource information. Please take a look for the information. I hope this becomes a good resource for you.

See I told you I am not Dave Barry.

SBIR Company Must Read

If you are a SBIR company you need to subscribe to Rick Shindell and his news letter. I have not read a more comprehensive report on the ongoing political struggles of the SBIR program. And no one is more engaging in their writing than Mr. Shindell.

If you are a company that takes advantage of the SBIR program or are considering it take a look at Mr. Shindell's website at Zyn Systems. He gives updates on political happenings including issues such as VCs rolls in the SBIR program, adjustment to award amounts, the politicians involved in re-uping the program, changes to personnel in the administrative portion of the program, and anything else you can think of.

I write this because I look forward to his newsletter not only because it is informative but because I strive for my writing to be as engaging as his. Anyone who can mix vampires from Twilight, news media personalities such as Glen Beck and Chris Mathews, and politicians is doing alright. Oh wait. Maybe that isn't much of a stretch.

State R&D Tax Credits

While most of the literature you read on the R&D tax credit focuses on the federal credit, there are tax incentives given by most states for R&D activities. Many of these state credits are not as lucrative as the federal credit but they lack tax nuances such as AMT limitations, NOL carry forwards, ... Therefore, some companies that cannot use a federal credit may still have tax to offset on the state level. ANd these credits can be substantial. My home state of Indiana, for example, has a credit that is more lucrative than the federal credit.

The question becomes, how do you know if the states you conduct R&D in have state R&D tax credits? State tax websites are hard to navigate and some college tax departments have summaries of credits but they do not provide the whole picture (forget knowing if the information is reliable). Well, hopefully you use Hull & Knarr to get this information. We have been collecting information from the states and we are posting it on our website, www.hullandknarr.com, within the next week. You will be able to get information on how the credit is calculated, carry forward and back years, credit expiration dates, and any special instructions for pre-filing applications. With the sourcing links you should be able to get yourself in the right direction for filing a state credit to either further supplement your federal R&D claims or benefit from a credit that is previously been unavailable.

I will keep you posted for when the interactive map with the information goes live. If you have questions now feel free to send them my way. Cheers.

Patrick

Start-up Companies and R&D Tax Credits

Just the other day a client sent me some information regarding a company he started with some other people within the last year. The company is small but revenue is quickly growing in this first year. And while they were are not profitable, yet, he understands the Federal R&D Tax Credit can be carried forward 20 years.

His question was, is the cost benefit there for me to perform a R&D Tax Credit study? After looking at the numbers, my recommendation was no. Start-up companies have too many other issues to deal with without me asking them for a bunch of information that will not benefit them for a year or two. Especially when the tax returns are open for amendment for 3 more years. But, that did not mean they should not take action now.

Since the IRS Tier 1 directive in April 2007, IRS Field agents are looking for more contemporaneous engineering and accounting documentation to substantiate claims. This means they want to see engineering notes, sketches, calculations, testing data, drawings, ... And they want to see some method of tying employee time to the qualified research activities associated with these documents. This means contemporaneous time tracking data. Ahhhhhhhhh!

The ideal method of tracking time for the credit would be to have each person's time tracked by project by task. But this is not realistic for most companies because it does not match their corporate culture. The IRS and the tax courts understand this.

After explaining this to my client's start-up, we have begun the process of incorporating Employee Time Allocation Questionnaires to be completed every month. This meets the IRS requirements and minimizes the intrusion on the company's time. In addition to tracking time, the company now understands the importance of keeping all of their engineering documentation no matter how dirty and sloppy it may be.

As a result of taking a few simple steps, this company now has the tools to substantiate a significant R&D Tax Credit in the future and they are reducing the money and man hour expense of performing the eventual R&D Tax Credit Study within the next year or two.

So this is a call out to all accounting firms, companies, employees, ... If you are associated with a start-up company that is performing R&D take action and call someone that can give you some help to do the same things that my client has done. Anybody that you consult should not charge you any money for this help because it will not take long and they should look at it as trying to grow a relationship with you. And you can use this opportunity to see if the person you are consulting is looking out for you. I hope this helps someone.

First Posting

I am not going to say much in this because I have spent some time setting this up and I am eager to put a post up to see how this displays. I will say that the R&D Tax Credit is a fantastic incentive for companies to perform R&D here in the United States rather than abroad. Many other countries use these incentives to attract business. Ireland is a perfect example of this. Because of their R&D tax incentives Ireland is viewed as a hub for research activities. Establishing this credit is one thing our politicians have got right.

What they are not getting right is the fact that they would rather use the R&D tax credit as a political football to push their own less popular agendas. Basically they are using a piece of the US' future as a bargaining tool. And while this is occurring companies are moving high tech jobs overseas to Ireland, India, and China. Making the credit permanent is a good first step to make sure high tech jobs stay in the states.

I could keep going but I am going to stop. I would rather just ask anyone who reads this material feel free to critique, complain, and just comment on anything I write. Any contributions will only make this blog more informative. Thanks.