R&D Tax Credit Offers Engineering Firm Six-Figure Savings Annually and the Opportunity to Transform Those Savings into Future Wealth
By taking advantage of the Research and Development (R&D) Tax Credit, an engineering firm may save up to $152,000 per year in federal taxes and up to $234,000 per year at the state level. These substantial savings may generate future wealth for the firm when applied toward a tax-favorable deferred compensation plan.
A mid-sized engineering firm based in Phoenix was seeking opportunities to maximize its tax savings and strengthen its financial situation, both in the present and the future. The firm is committed to developing innovative solutions that promote sustainability and public safety across a variety of industries, including construction, energy, and aviation. Considering their past projects, the firm’s executives consulted the tax experts at Capital Review Group (CRG) to review their records and determine whether they may be eligible for the Research and Development (R&D) Tax Credit.
As the CRG team began developing a customized tax strategy for the engineering firm, the following challenges arose:
- Determining the optimal methods for maximizing tax savings in light of the firm’s structure as a C-corp.
- Identifying activities that may qualify for the R&D Credit.
- Leveraging any tax savings gained to fund a tax-favorable deferred compensation plan for the firm’s executives and key employees.
Minimizing the Engineering Firm’s Tax Burden Through the R&D Credit
Businesses in a wide variety of industries, including engineering, may be eligible for the R&D Credit based upon their routine activities. To qualify for this lucrative incentive, a business must fulfill the following four-part test:
- Permitted purpose: the business must intend to create new or improved functionality of a product, process, or software.
- Elimination of uncertainty: the business must seek to eliminate uncertainty regarding the activity’s design, method, process, or cost.
- Process of experimentation: in attempting to eliminate the uncertainty, the business must perform a process of experimentation designed to evaluate one or more alternatives. This process may range from informal trial and error to computational analysis and modeling.
- Technological in nature: the process of experimentation must be technological in nature and must rely on engineering, computer science, or the physical or biological sciences.
Engineers commonly engage in several activities that may satisfy this test, such as testing different design concepts, developing sustainable building plans, or navigating complex building codes or site conditions.
After a preliminary review of the Phoenix engineering firm’s records, CRG found that significant opportunity existed for the firm to claim R&D credits at both the state and federal levels. Specifically, CRG estimated that the firm may be able to save between $117,000 and $152,000 per year at the federal level, and $180,000-$234,000 per year in Arizona. Additionally, the firm would be able to carry excess credits back as far as tax year 2014, or possibly even 2013. However, since rate limitations exist in Arizona, CRG advised that $170,000 per year would be a reasonable estimate at the state level—which would still mean that the firm could claim $500,000 in Arizona R&D credits alone for tax years 2014-2016.
Leveraging Tax Savings to Yield Future Wealth for the Firm’s Employees
Based on the engineering firm’s specific needs and goals, CRG developed a proposed strategy to apply $170,000 of tax credits per year to a tax-favorable deferred compensation plan for the benefit of the firm’s executives and key employees. This plan represents just one option for how the firm can use its credits to create future wealth.
The deferred compensation plan that CRG proposed features the following benefits:
- 100 percent funded by tax savings, with no cost to the firm.
- Invested in a way that eliminates volatility and the risk of loss.
- All growth of the account is tax-deferred, meaning that no taxes are due on an increase in value.
- The initial death benefit is approximately $4 million.
- Plan participants may receive pension income of $283,000 per year beginning in year 15 and continuing through age 100—resulting in a total value of $9.9 million.
- The firm may boost workforce retention by using the plan’s vesting schedules for key employees.
- The plan’s net asset value will appear on the firm’s balance sheet.
By maximizing tax savings through the state and federal R&D Credits—and then applying those savings toward a tax-favorable deferred compensation plan—the engineering firm can achieve its goal of enhancing financial well-being in both the present and the future. CRG will continue to work closely with the firm to seize all available tax savings and use those savings to develop an optimal long-term financial strategy.
Wondering if your firm may be eligible for the R&D Tax Credit? Contact CRG today to schedule a pro bono analysis!