In this episode of the Management Blueprint Podcast, Julio Gonzalez, Founder and, CEO of Engineered Tax Services and I talk about tax engineering, tax incentives for small to medium-sized businesses, and work opportunity tax credits.
Listen to Julio Gonzalez, Founder and, CEO of Engineered Tax Services discuss tax-saving strategies on The Thoughtful Entrepreneur Podcast.
There’s been a disturbing change in precedent as practiced by the IRS: IRS audits of research and development (R&D) tax credit claims by service providers, such as architecture and engineering (AE) companies, have become inconsistent over the last couple of years. In fact, IRS audit actions appear to be reversing the long-standing precedent for the type of activities that qualify for the credit. Up to now, service providers have qualified for the R&D credit as long as they satisfied a four-part criterion (outlined below).
First off, what is the R&D tax credit? It was established by law in 1981 to act as an incentive to spur U.S. research and economic competitiveness and made permanent in 2015. It remains critical to the growth of U.S. innovation. To qualify, research must entail activities that satisfy a broad four-part test. The activity must include the elimination of uncertainty, the process of experimentation, be technological in nature, and have a qualified purpose (the business component test).
Historically, two main groups benefit from the credit: manufacturers and service providers. Nearly half of taxpayers who claim the credit are manufacturers, while nearly one-third of taxpayers who claim the credit are service providers–most of which are small businesses in the fields of architecture, engineering, construction, and computer software design.
Despite this longstanding precedent, recent audit denials for architecture and engineering research claims are reflecting a very different position by the IRS, which now argues that “services” do not qualify for the R&D tax credit. This dramatic break in precedent has an outsized impact on small businesses that lack the resources to fight IRS denials. While the IRS’s stated reason for disallowances has varied from case to case, a consistent theme from IRS examiners in the Small Business/Self-Employed division argues that services provided by architecture and engineering firms cannot meet the “qualified purpose” portion of the four-part test because their research lacks an identifiable “business component.”
This new position is concerning, given that the IRS Code clearly defines the term “business component” as a product, process, computer software, technique, formula, or invention. In the past, the IRS has allowed design drawings to qualify as the business component, since the term “technique” is synonymous with the term “blueprint” or “design drawing.”
However, in many recent cases, the IRS has ignored the terms “technique” and “formula” in R&D claims for service providers altogether. While no court cases have addressed this issue directly, there have been cases involving service firms that took the R&D credit where neither the IRS nor the courts questioned whether service providers can qualify for the credit; this shows service providers aren’t inherently disqualified from taking the credit.
The architecture and engineering industry in the U.S. employs millions of Americans conducting essential research and development activities that are vital to achieving U.S. advancements and innovations in clean energy, safe and modernized infrastructure, and health-conscious building design and construction in a post-pandemic world.
This is exactly the type of innovation and R&D expertise that political leaders on both sides of the aisle want to continue to foster here in the U.S., and it’s clear that IRS guidance that’s consistent with the longstanding Congressional intent for the type of U.S.-based innovation this credit was designed to promote is needed to ensure this industry can achieve our next generation of safe, reliable, and sustainable infrastructure goals.
If the IRS is allowed to unilaterally change the R&D credit’s applicability to the AE service industry, it stands to set a dangerous precedent that will damage U.S. innovation, as well employment and wages in this critical sector, and it could potentially prove inflationary to the construction industry.
It’s for this reason that I’ve teamed up with tax professionals to formally request the IRS include clarifying guidance for computing and substantiating the qualifying research activities performed by service firms, such as architecture and engineering firms, under I.R.C. § 41 in its Priority Guidance Plan for 2021-2022.
Specifically, we’re asking for the IRS to provide formal guidance in the form of a Revenue Procedure or Ruling modeled after the 2012 IRS Guidance for Computing and Substantiating the Credit for Increasing Research Activities Under Section 41 of the IRS Code for Activities in Developing New Pharmaceutical Drugs and Therapeutic Biologics.
Under this proposal, guidance could be developed that creates a “checklist” of activities conducted by taxpayers in the AE field that qualify for the research credit and that are subsequently certified to appropriately compute the credit. As in the pharmaceutical industry’s guidance model, if a taxpayer meets the criteria and makes the appropriate certification with their tax returns, an audit would be unnecessary.
This approach would ensure the research tax credit is consistently and fairly applied to a critical industry and, importantly, would alleviate the considerable amount of time and resources the IRS SB/SE exam function is currently spending auditing research tax credits for these small businesses, freeing up valuable IRS audit personnel to address other important Administration tax priorities.
This type of approach is in the best interest of the U.S. government and taxpayer, and we’re encouraged that the groundswell of bipartisan support to protect and improve this critical research tax incentive will lead to fair and clear IRS guidance that allows these important small businesses to continue to deliver the R&D innovations our country is relying upon.
Recently Sen. Ron Wyden (D-Oregon), chairman of the Senate Finance Committee, reintroduced the Clean Energy for America Act (CEAA). Of interest to those in the energy efficiency community — ranging from commercial real estate to tax, architecture, engineering and construction — the legislation proposes to continue to build on the tax code’s energy-efficiency provisions, recognizing the critical need to focus on both energy demand and supply in addressing the climate and carbon emissions reduction.
WEST PALM BEACH, FL – Just when you thought Jeff Bezos’ thirst for power over every aspect of our daily lives had been satiated, he’s now set his sights on the world of accounting. Business Insider recently reported that Bezos has put $100 million behind Pilot, a startup that aims to dominate the world of accounting and tax services for small and mid-size businesses in the United States.
This investment, which has helped the company earn a valuation of $1.2 billion, has Pilot on pace to be the country’s largest accounting firm. As someone who has been in the business for nearly 30 years as the CEO of Engineered Tax Services, this is unheard of and completely unprecedented.
Founding and owning a successful business doesn’t necessarily insulate someone from potential financial difficulties. Indeed, balancing the needs of the business with personal financial needs can be an ongoing challenge. And like everyone else, business owners need to develop a plan to provide for and protect themselves and their families in retirement.
No matter the stage your business is in, it’s always wise to start planning for the future. Below, a panel of 13 Forbes Finance Councilmembers shares tips to help business owners prepare for retirement.
How Increasingly Taxing The 1% And Corporations Can Hurt The Economy
It’s a beloved narrative: The wealthy need to pay their fair share. But just how much of what an individual or corporation earns from their labor is the government justifiably entitled to take? Opinions vary, but the current administration has focused on raising the amount the nation’s wealthiest pay in taxes. The target of recent proposals are those in the top 1% income bracket as well as corporations. But when taking a closer look at the numbers and how they play out when taxes are increased or decreased on top earners, I believe it becomes less straightforward than, “Tax those who make more even more, and everyone wins.”
Investors watch interest rates closely and carefully. In some cases, high interest rates are good news—such as when an investor is expecting a return from a high-yield financial account or investment vehicle. In other cases, high interest rates can hurt a portfolio’s performance. In those cases, investors will want to be prepared for sudden market changes.
As the Treasury continues to signal a likely rise in interest rates, it’s wise for investors to be aware of all the implications. Below, eight experts from Forbes Finance Council share strategies investors can leverage to protect their portfolios from a rise in interest rates.
President Biden’s Sweeping Proposed Tax Law Changes: Is This the Right Time?
On the night of Wednesday, April 28, President Biden addressed a joint session of Congress and unveiled the second portion of his Build Back Better agenda – the American Families Plan, a $1.6–$2 trillion social infrastructure/human capital initiative focused on fighting poverty, investing in childcare and education (free community college), improving workforce development, and potentially expanding health insurance subsidies. The proposal seeks to raise $1.5 trillion over a decade via higher taxes on the top 1%. Biden plans to finance the plan primarily through tax changes aimed at upper-income taxpayers, defined as individuals and married couples making more than $400,000 a year.
Here were his proposed major tax changes:
Here’s the fundamental problem with this proposal: raising taxes doesn’t work, and in the wake of the destruction that COVID-19 has visited upon our economy, this isn’t the right time.
Raising taxes didn’t work when they did it in New York or California. A few years ago, when the income tax level came down to the lowest of all time with the lowest unemployment, we saw the corporations return to the United States. Now that we’re raising taxes for the corporations and the highest earners, they’ll flee to international tax havens like Canada and Ireland. And if raising taxes on the top 1% didn’t work on the state level, it’s certainly not going to work at the global level. I’m concerned that this move will hurt the economy rather than help it as intended.
Much has been made of the fact that Biden has assigned a $400,000 income cutoff level for imposing new taxes. The fallacy with that concept is, higher earners will always find new ways in our tax system to preserve wealth; they always do. They’ll set up offshore accounts and utilize tax depreciation to minimize their taxes.
What President Biden is really proposing is a burden on the middle class and the lower class. That’s what always happens when taxes are hiked on the drivers of our economy. They’re going to take the jobs offshore, and when they’re pull their money offshore, that’s going to create hyperinflation—and that’s going to hurt the middle class.
My other major concern is: how are we going to pay for all the ambitious projects Biden outlined in his Wednesday night address? At this rate, his out-of-control spending will run up the national debt to 15% of our Gross National Product. Eventually the bottom is going to fall out of our economy.
By the way, do you know that only 6% of his infrastructure bill actually goes to infrastructure, to job creation? The rest goes to the social redistribution of wealth from taxpayers to nontaxpayers. That doesn’t create jobs—it creates dependency.
As someone who helped advise on the 2017 Tax and Jobs Act, I’m concerned President Biden’s proposed sweeping changes to the U.S. tax law could have the unintended consequence of undermining his ambitious social agenda. By unfairly burdening America’s top earners, he could well end up slaying the goose that lays the golden eggs.
For years now, the architectural, engineering, and construction community has been receiving the research and development tax credits it deserves for fostering innovation in its creation of America’s vital infrastructure.
But recently the architectural, engineering, and construction community has begun seeing an increase in unfair denials of these credits by the Internal Revenue Services, breaking with the long-standing application of the research and development tax credit for businesses that provide these important services.
When my company, Engineered Tax Services, which represents members within the architectural, engineering, and construction community, brought up this fact in meetings with members of the U.S. House Ways and Means and U.S. Senate Finance Committees last year, they were concerned that inadvertent IRS actions could stifle innovation at a time when it’s crucial for America’s future.
Here’s the imperative situation: The U.S. is losing high-paying jobs tied to manufacturing and innovation to competitive overseas markets. The R&D tax credit is one of our country’s best defenses to try to stem this loss.
This is because the R&D tax credit is, in reality, a jobs credit — a wage credit — that incentivizes businesses to create and keep high-paying and strategically important jobs in the U.S. that help us maintain our competitive edge in next-generation design, manufacturing, technology, and medical breakthroughs.
Architects and engineers are a vital part of this R&D industry and our economy overall — they comprise the middle class that earns $100,000 to $150,000 a year and are critical to the success of our country’s goals to achieve climate-conscious building and infrastructure advancements for the future.
The fair and consistent application of the R&D credit for architectural, engineering, and construction service businesses is essential to keeping this workforce in the U.S.
This is particularly important as the U.S. faces steep competition for this field of experts. As a 2020 Ernst & Young study shows, many other countries have better, more lucrative R&D tax incentives than the U.S.
Several countries have gone so far as to introduce what is known as a patent box, a special very low corporate tax system that incentivizes research and development by taxing patent revenues differently from other commercial revenues.
America’s strong economy depends on two primary factors: access to capital markets and a strong workforce. That’s why we have such a high standard of living.
But capital markets are under stress now, particularly if the U.S. dollar isn’t backed by high-paying jobs generating income tax. And if you drive away strategic jobs in the $100,000 to $150,000 wage range, our economy will suffer.
On top of this, the architectural, engineering, and construction community delivers notable design innovation that directly benefits the public good. Here are some examples:
Why has the IRS been denying R&D tax credits to the architectural, engineering, and construction community more often lately? It’s not really the agency’s fault.
You see, with few exceptions, the architectural, engineering, and construction community falls into the IRS’ small business category. Unfortunately, while the IRS unit that audits large businesses has ready access to full-time engineers equipped to scientifically analyze R&D tax credit submissions, the small business unit typically does not have access to the same level of resources. As a result, the analysis is often left to examiners who are unfamiliar with the mechanics of innovation.
According to Kreig Mitchell, a Texas-based attorney who specializes in federal and state issues, “In addition, some cases are larger in scope, and it is not uncommon for one audit to experience multiple agent turnovers, further complicating the consistency of the audit.”
Another issue is that despite the fact that architectural, engineering, and construction businesses have qualified for the tax credit since its inception in 1981 and, by the IRS’s own statistics, account for approximately one-third of the R&D credits approved each year, recently some in the IRS appear to be viewing architects and engineers solely as service providers, believing they sell nothing but their services, so the “product” being innovated via R&D is less clear than with manufacturing and software companies.
“Recent credit denials make it clear that current agency staff are not taking into account A&E firms’ intensive scientific expertise,” Mitchell said, “and the fact that of course, they have to apply innovation to overcome technical obstacles, such as designing a building in an unusual shape aerodynamically to prevent it from collapsing.”
This and other examples reflect the regrettable fact that there’s a gray area in the tax code. The criteria used to judge whether a business qualifies for R&D tax credits requires projects to pass a complicated four-part test that is open to interpretation, and that’s where the architectural, engineering and construction community is running into trouble.
When we take into account the fact that the IRS has even pressed novel theories for the research tax credit that have not been accepted by the courts, it underscores the need for clarity for this important industry. Unfortunately, those of us in the small business community don’t have the resources to constantly counter the IRS’s costly audits that typically play out over several years for contested R&D tax credits.
As it stands now, companies seeking R&D tax credit approval should carefully review the IRS ruling that lays out the criteria under which their credits will be judged, and they should understand the four-point test they must pass.
Companies should undertake careful time tracking, project accounting, and concise, organized note-taking so the IRS can clearly see where research efforts have been directed. They must discuss the research they’ve undertaken and describe in detail their funded research.
Taken together, these guidelines can greatly enhance a company’s likelihood of having its R&D tax credits approved.
Given the recent inconsistencies in IRS assessments of the R&D tax credit for this industry, it’s clear that clarifying guidance in the form of a revenue ruling or other guidance from the IRS is both merited and needed to ensure small businesses in our critical architectural, engineering and construction community have a fair playing field and an opportunity to continue to innovate here in the U.S.
In the past, the IRS has demonstrated its willingness to amend, clarify or revise its interpretation, as we saw last year in its decision to allow the deduction of Paycheck Protection Program loans and its November 2020 ruling to apply bonus regulations retroactively.
More directly, the IRS issued similar guidance clarifying how the R&D tax credit applies to the pharmaceutical industry in its 2012 memorandum “Guidance for Computing and Substantiating the Credit for Increasing Research Activities under Section 41 of the Internal Revenue Code for Activities involved in Developing New Pharmaceutical Drugs and Therapeutic Biologics.
This type of clear, clarifying guidance for the architectural, engineering and construction industry would benefit the government and taxpayers by ensuring this important element of the tax code continues to yield a strong and direct benefit to America’s economy and to the critical small businesses we will rely on for our next generation of innovation in the U.S.
Disclosure: ETS has raised this issue with members of Congress on the House Ways and Means and Senate Finance Committees.
The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
 https://engineeredtaxs.wpengine.com/research-development-tax-credit/.  https://engineeredtaxs.wpengine.com/.  https://www.oecd.org/unitedstates/us-manufacturing-decline-and-the-rise-of-new-production-innovation-paradigms.htm; https://hbr.org/2020/04/bringing-manufacturing-back-to-the-u-s-is-easier-said-than-done.  https://en.wikipedia.org/wiki/Upper_middle_class_in_the_United_States.  https://www.ey.com/en_gl/tax-guides/worldwide-r-and-d-incentives-reference-guide-2020.  https://en.wikipedia.org/wiki/Patent_box.  https://www.gensler.com/uploads/document/434/file/gensler-climate-change-2016.pdf.  https://damsafety.org/sites/default/files/Cost%20of%20Rehab%20Report-2016%20Update_1.pdf.  https://www.fhwa.dot.gov/bridge/abc/.  https://nacto.org/docs/usdg/flexibility_in_highway_design.pdf.  https://www.epa.gov/sites/production/files/2015-07/documents/con-bld05_0.pdf.  https://www.news-leader.com/story/news/local/ozarks/2020/05/28/springfield-homeless-tiny-home-eden-village-ii-home-builders/5259847002/.  https://engineeredtaxs.wpengine.com/research-development-tax-credit/.  https://www.irs.gov/pub/irs-soi/14co01rsrchcr.xlsx.  Examples include Poplous Holdings v. Commissioner, Docket No. 405-17, arguing that an architect firm only sells drawings; Siemen Miller, cite, arguing that no credit for a project that spans several years; Trinity Industries Inc. v. U.S., 691 F. Supp. 2d 688 (N.D. Tex. 2010), arguing that a project incorporating components from third parties does not qualify; and Suder v. Commissioner (T.C. Memo. 2014-201), arguing that taxpayer with engineering know-how knows engineering and therefore cannot qualify for credit.  https://www.irs.gov/businesses/audit-techniques-guide-credit-for-increasing-research-activities-i-e-research-tax-credit-irc-41-qualified-research-activities.  https://nhlnk.co/api/v1/track/link/click/5a1f77ddcba395a9bd857e4e/1614184609595/?link=https%3A%2F%2Fwww.irs.gov%2Fnewsroom%2Feligible-paycheck-protection-program-expenses-now-deductible.  https://www.irs.gov/businesses/guidanceforcomputingsubstantiatingpharmaceuticaldrugstherapeuticbiologics