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Read this before paying 20-30% R&D Tax Credit fees

Blog | April 27, 2021

The only reason to pay 20-30% R&D Tax Credit fees

The IRS requires businesses claiming the R&D Tax Credit to maintain documentation proving the business engaged in Qualified Research Activities (QRAs) and that the Qualified Research Expenditure (QRE) being claimed on Form 6765 are directly tied to those research activities. 

Accountants who don’t perform R&D Tax Credit Studies for their clients often outsource the work to providers who charge 20-30% of the tax credit in fees.

But be careful! They aren’t always advertised as such. Some firms advertise their incredibly high fees as “X percent of QRE” to unsuspecting clients. 

Which sounds like the better deal to you: “2.5% of your QRE” or “20-30% of your tax credit”?

Take a look at the numbers here. The R&D Tax Credit is calculated by multiplying QRE by between about 6-10% of QRE depending on several variables.

Paying 2.5% of QRE means you're giving up anywhere from 25% to more than 40% of the actual tax benefit. 

Even for startups and small businesses, fees in this range can amount to $10,000s to $100,000s in cash flow that could otherwise be reinvested in the business. 

Let’s be clear: the only reason a business should ever pay 20-30% of their R&D Tax Credit in fees is for a complete R&D Study that results in bulletproof documentation of Qualified Research Activities that will protect the tax credit in the event of an IRS audit.

That’s it!

Double-check these red flags when evaluating R&D Tax Credit providers who charge 20-30% fees

1.  Is the R&D provider offering a cash advance in exchange for a high fee? 

Cash advances are a marketing ploy. The only reason to pay for anything related to the R&D Tax Credit is for an R&D Study that results in bulletproof documentation that will defend the startup’s tax credit claim in the event of an audit. If the provider’s documentation isn’t going to defend the startup under audit, it’s not worth paying for.

It's worth noting that a cash advance is effectively a high-interest loan to the startup: they pay a 20% fee (or more) to get the money now instead of next quarter (after filing for the tax credit, you have to wait a quarter before you can actually apply it), which means they could be paying an equivalent APR of over 80%.

2.  Did you find out you qualify for the R&D Tax Credit by simply linking your payroll software with the provider’s?

If so, this means the provider is only looking at job titles to determine whether an employee qualifies for the R&D Credit. Just because an employee’s job title is “software engineer”, doesn’t necessarily mean the work they do qualifies as R&D per the IRS criteria. 

A legitimate R&D Study will review the activities performed by each employee and the projects they worked on during the tax year to determine how much of their time was spent on Qualified Research Activities. 

3.  Does the provider’s R&D documentation contain boilerplate language about job responsibilities that looks like it's been copy and pasted for each employee?

If the documentation looks like someone went through and checked a box for each job responsibility that applied to each member of their team, with many employees having the same language describing their job responsibilities, that should be a red flag.

Simply stating the person had job responsibilities is not evidence of their involvement in Qualified Research Activities.

 

4.  Does the provider advertise their fees as a % of QRE?

As noted above (but worth repeating), this is more of a heads up than a red flag. Often firms advertise incredibly high fees as “X percent of QRE” to unsuspecting clients.

Which sounds like the better deal to you: “2.5% of your QRE” or “20-30% of your tax credit”?

Take a look at the numbers here. The R&D Tax Credit is calculated by multiplying QRE by anywhere between about 6-10% of QRE depending on several variables.

Paying fees equal to 2.5% of QRE means losing as much as 25% to more than 40% of the actual tax benefit. the business

 

5.  Is the R&D provider counting 100% of the wages for every “qualified” employee?

If so, ask the provider how they made that determination. Rarely is 100% of a person’s time spent on Qualified R&D activities. 

The IRS allows businesses to claim 100% of an employee’s wages as Qualified Research Expenses for those who spend “substantially all” of their time (80% or more) on Qualified R&D Activities. Be sure you’re able to prove an employee met the 80% threshold if you’re claiming 100% of their W2 wages as QRE.

 

6.  Does the R&D provider require clients to pay upfront?

After filing Form 6765, Credit for Increasing Research Activities (the R&D Tax Credit’s formal name), you have to wait a quarter to actually apply the tax credit. In other words, there’s a minimum 90-day delay between the filing and seeing any benefit.

Most reasonable R&D providers are willing to delay payment until the business sees the benefit.  If the R&D provider being evaluated won’t budge on this, look elsewhere. Especially if they’re charging a 20-30% fee upfront.

 

7.  Is the R&D provider advertising minimal time (or effort) commitment as a selling point?

The only worthwhile reason to pay 20-30% of your R&D Tax Credit in fees is for the firm to do a careful, in-depth review of each employee’s activities to ensure the activities qualify as R&D per the IRS rules and determine how much of their wages or contract expenses are eligible to be claimed as Qualified Research Expenses.

While we’re not suggesting spending days or weeks to complete what’s required, the firm’s diligent R&D Study process and resulting R&D documentation should be the primary consideration when selecting R&D providers. Not minimal time and effort.

It's a real benefit if the R&D provider doesn't need to interview every employee.  But if they advertise that the R&D Study doesn't require any real involvement from the startup or its leadership, you should be suspicious that they're not doing much of an analysis.

 

8.  Is the R&D provider claiming wages for salespeople and other non-technical employees as QRE?

 In addition to the wages of employees (and contractors) conducting the ground-level R&D work, the IRS allows businesses to claim Qualified Research Expenses for managers directly overseeing the R&D work, as well as administrative employees who are directly supporting the R&D work. In other words, employees one step above, and one step below the R&D.

Remember, in order for an activity to qualify as R&D per the Four Part Test, it has to be technological in nature and rely on the principles of one of the hard sciences or computer science. The IRS Audit Guidelines go as far as to specifically exclude research in the social sciences, including economics, business management, and behavioral sciences, arts, or humanities. The wages of salespeople and other non-technical employees should not be counted as QRE unless activities they conducted during the year passed the Four Part Test.

 

Conclusion

If you encounter any of these red flags when evaluating an R&D Tax Credit provider, it's likely worth seeking out an alternative.

RetroacDev was built to help accountants and tech businesses leverage data analytics and automation to claim the R&D Credit and protect the business with strong, data-driven Qualified Research Activity documentation.

Get in touch with us today to find out if RetroacDev is a good fit for your business.

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