‘That’s not R&D’: Changing how engineers view R&D can increase tax credits
“That’s not R&D” is a common phrase we hear from engineers at companies engaged in product development and improvements. Engineers typically don’t view a large part of their day-to-day activities as worthy of the lofty moniker of research and development. It’s this exacting nature and detailed focus that makes an engineer good at his or her work, not how well they interpret the Internal Revenue Service definition of R&D.
This is good news for businesses that may be underclaiming R&D credits because these frontline personnel aren't aware of the breadth of eligible activities. Teaching in-house engineers what “qualifies” for R&D credits puts more boots on the ground looking for R&D credit opportunities for the company.
The most common question we get from clients is, what qualifies for R&D credits? The working definition engineers tend to apply to R&D is much more stringent than the definition the IRS uses for eligible R&D credits.
The congressional intent behind R&D credits is to motivate companies to hire engineers and perform research in the United States. As such, the IRS has implemented a lower standard than the average engineer thinks, which is perhaps made clearer by what R&D isn’t in the eyes of our nation's tax authority. The IRS doesn’t use the word “discover” or the phrase “never been done before” in describing what constitutes R&D. Instead, the agency focuses on technical uncertainty and what process of experimentation is performed to eliminate that uncertainty.
For R&D credit purposes, when a company is coming up with a solution, performing modeling on projects, and defining what makes their project different from any other road or building, the focus isn’t on what is novel but rather the technical uncertainties that the engineers are looking at to prove the project will work.
Technical uncertainties must be identified, measured and tested in a technical evaluation. While under construction, the Florida International University pedestrian bridge collapsed, killing six people in 2018. The bridge had a fatal design error in the load and capacity calculations, according to an examination by the Federal Highway Administration. Were there uncertainties that engineers on that project could have tested and modeled in a technical evaluation to ensure carrying load and capacity prior to build?
The Big Dig through downtown Boston demonstrates another set of technical uncertainties. When sections of the highway sprung water leaks less than a year after opening, the all-encompassing question became, what went wrong? The engineering firm hired to expand transportation to Logan International Airport borrowed equipment used in building the Chunnel between England and France. Problems with that machinery led the firm to replace the equipment midway through the project, demonstrating uncertainty. Within the year, the Big Dig started springing leaks and fingers were pointed at the engineering firm, who had to fix the issues at a huge financial cost. Here again, there was technical uncertainty where the engineering firm’s design came into question.
Each of these projects demonstrates the nature of technical uncertainty. Until you dig into the ground and see what’s there, you just don’t know. That’s why most bridge, building and real property projects involve uncertainty and testing, thereby qualifying for R&D credits. When you do not know what is there and what will happen and need a technical evaluation to proceed, it is likely eligible for R&D credits, regardless of whether the project ultimately succeeds or fails.
Recognizing technical uncertainties
Technical uncertainties apply across all industries. A company moving small engines for lawn mowers from a carburetor to a fuel injection design won’t know what is going to happen before the build. It may not see a filter problem with grass stalling out the engine until the failure happens. Once a product fails, the company must go back to the drawing board and change the design.
This process of trial and error around technical uncertainties is what the law upholds as R&D, and it covers a lot of ground. This process has many components that take place day in and day out under the watchful eyes of detail-oriented engineers. Teaching engineers to recognize each element of the process that is eligible for R&D will help businesses maximize their claim to available R&D credits.