The following is a guest post from Richard Bernstein, an enrolled agent and former IRS R&D tax engineer at the IRS.
As an IRS engineer and R&D software expert for many years, I was once assigned to provide technical advice to a group of IRS executives tasked with creating what would become known as the ASC 730 Directive. The executive group had been instructed to draft a directive allowing large public software firms in Silicon Valley to claim the R&D credit without paying “big bucks” to their R&D consultants.
For large firms, these consultants are usually the R&D tax credit division of a Big Four accounting firm. For about a year, our group met at sites in Silicon Valley, Houston and Oakland, California, often with the Tax Executives Institute in tow. I was aware of the need for this directive because, while performing my regular duties, auditing the R&D tax credits of public firms, tax directors often confided in me that their staff had created the R&D credit in‑house because the charge from their Big Four accountant was just too high.
Another IRS employee drafted for this “directive creation” task was a knowledgeable revenue agent based in Ithaca, New York, named Jim. Before joining the IRS, Jim had a career as a CFO at a public firm, but left after some problems with the SEC. Jim, like me, had been assigned to this task due to his prior IRS experience in public accounting. Jim had a saying he often used, at the drop of a hat, when discussing taxpayers’ motivation to file for the R&D credit. He would say, “the tail doesn’t wag the dog” when referring to the R&D tax credit. What he meant was that, in his opinion, public firms will not alter their financial plans to optimize for the R&D tax credit. But in a slightly backhanded way, he also displayed his disdain for tax credits, in particular, and for engineers, in general. Ugh!
The question is: Does U.S. R&D tax credit policy encourage CFOs to create R&D projects in a way that creates a supportable credit, or is the R&D tax credit just a year-end, check-the-box, cleanup task?
Why smart CFOs sometimes leave money on the table
Smart CFOs often leave money on the table — especially around R&D and other tax incentives — due to information gaps, risk perceptions and how incentives are positioned within the organization.
The main reasons for this include:
Structural design. Due to the cost charged by the Big 4 for R&D expertise, the tax credit is targeted mostly to large firms, while small and midsized firms, which could benefit the most, see limited value due to risk. Additionally, frequent changes to tax law regarding the Treasury’s treatment of R&D expenses make it difficult to do long‑range capital planning.
IRS friction and compliance risk. Many finance teams consider the required documentation to be burdensome. This has only gotten worse with new IRS filing demands concerning business components. In addition, a few recent high‑profile IRS wins in Tax Court have left CFOs sensitive to audit risk. However, some software startups, such as TaxNova.ai, are developing tools specifically to address this problem. CFOs who surmount the documentation requirements will still need to hire experienced R&D experts to modify the documentation into an IRS-ready, R&D study. And ultimately, to defend the study before the IRS should it ever be audited.
Organizational perceptions. Some executives still believe that the R&D tax credit is only for laboratory R&D or big tech. This leaves many otherwise qualified firms missing the R&D tax credits. Many growth firms saw little value in a non-refundable tax credit in their early years, and these perceptions persist even after changes to the tax law that offset payroll taxes. In addition, many firms treat tax credits as a year-end tax cleanup task rather than a cash-flow lever and therefore never consider them in their capital allocation toolkit.
Sadly, some CFOs think that the easiest “design fix” is not to file for the R&D tax credit at all.
A different view from the field
But not everyone thinks the glass is half empty. Some, like Jad Meouchy, founder of BadVR, a small, privately held firm located in Los Angeles, feel differently. BadVR provides visualization services to the government and the private sector, and he feels that the R&D tax credit has been a positive for his business. Meouchy said, “A lot of what we do is building a future vision and executing on these unique ideas that, for example, our DOD partners have.” Meouchy further feels that the R&D tax credit “is a good incentive, not necessarily because we rely on it, but because anytime there’s a signal like that, it just kind of tells people what’s valued, and when innovation is valued and there’s an incentive for innovation, then all of a sudden, everybody wants to do innovation.”
Perception, rather than facts, often limits the use of the R&D tax credit in the U.S. With over a hundred thousand U.S. firms taking this tax credit annually, CFOs should consider how their own biases affect the bottom line.
