In this episode, Jamie Nau our host and Director of Accounting joins Randy Crabtree the co-founder, and partner of Tri-Merit Specialty Tax Professionals together with Adam Hale, Partner at Anders for a quick speed dating session with tax credits and incentives. They will go through six different credits and incentives that CPA firm owners and accountants should know about to help their clients save tax money.
"It's very important to look at all these tax-saving opportunities." - Randy Crabtree
The finer details of this episode :
Episode resources
Speed Dating with Credits and Incentives
Jamie Nau: Hello, everybody. Welcome to today's podcast. I'm really excited for today's topic because we're going to do some speed dating, which we will get into in a little bit here with Randy, but real quick, I want to welcome Adam to the show again.
Adam Hale: Hello, everybody.
Jamie Nau: Our guest today is Randy Crabtree, who's with Tri-Merit. He's a partner over there. And before the show, he was kind of talking about how he likes to introduce different types of credits and kind of thinks of it as speed dating for business owners and accountants to know what the credits are and really jump into it. Randy, you want to explain that topic a little better than I did.
Randy Crabtree: Yeah, sure. I mean, we can go into anything you want when we're talking about this, but I mean, it may be geeky, I don't know, but I just love talking about credits and incentives. There's so many opportunities out there for taxpayers, or CPAs to help their taxpayers, save some money.
I just developed this webinar, and I do webinars all the time. I just developed this webinar back in November or something and have been doing the version of it lately, which I’m calling Permanent Tax Credits and Incentives: What Your Clients Need to Know Post COVID Relief.
But when I'm talking, what I really say is, “Hey, what we're going to do is, we're going to do speed dating with credits and incentives. I'm going to talk about these six different things. You're not going to become an expert in the hour that we're doing this, or the 30 minutes we're doing this. But, I want to give you a high-level idea of what's going on with these and then speed dating.
And then after that, you, as the tax preparer, are going to play matchmaker. You're going to take whatever credit or incentive you found interesting, one that you found that ABC client or XYZ client could use. And you're going to introduce it to them, and you'll hopefully save them money and become a hero in this whole process.”
Jamie Nau: I'm excited to get started, so let's hear the overview.
Randy Crabtree: All right. I'm going to jump into it. So the problem is, Jamie, when I start going, you're going to have to interrupt me to stop me. So, interrupt me anytime if I'm going off track. I just love talking about this stuff.
And the reason is, when we're talking about credits and incentives, again I told you I get excited on this stuff, clients and taxpayers, we've been programmed for the last two years through COVID relief that there's money out here available for you. There's PPP, there's employee-retention credit, there’s child tax credits, restaurant-revitalization grant, FMLA, FFCRA.
All these different things were out there and people realized it, and taxpayers realized that there's potential benefits for them, but that doesn't end with COVID relief. There are things that have always been part of the tax code that are out there that can do the same thing for you.
And there are things that are still part of COVID relief that are going to exist for the next few years. So what I do is go into that, and, if you want, I can just list all six and we can decide if we want to talk about one.
Adam: Yeah, absolutely. If you want to fire off.
Randy Crabtree: Let's do it. So there's really, like I said, six things that I spend time talking about.
They coincide with the six offerings that we do as a business. But research and development tax credits. And that sounds like you have some audience that may be very interested in those. So research and tax credits have been part of the tax code for a while. There's some real estate types incentives, cost segregation, which is accelerating depreciation on depreciable property. 179D, which is accelerated depreciation for commercial property that's energy efficient, and there's two ends of that.
One is anybody who owns a commercial property, but two, if you were a designer of a government building, you can potentially get this Phantom deduction, which ends up being free money to that taxpayer as well. 45L, which is a credit for developers of low-rise, residential properties–actually significant benefit there.
Those last two, 179D and 45L, big proposals to actually increase the benefit on those. Hopefully, it will go through in the next few months or so. They were supposed to go through in the Build Back Better bill, but that's just been sitting on hold for a while. We'll see what happens.
And then the two others that I talk about are employee-related. Work opportunity tax credit is a new-hire credit; anytime you're hiring somebody that meets a certain geographic or demographic requirement, you can get a credit for that.
And then the big one, which everybody's heard about. Everybody's getting marketed to on is the employee retention credit–the most marketed tax incentive in the history of the world.
And then, R&D, I'll get off my soap box for a second. Probably the most misinformation out there than any other credit I've ever, R&D was misinformation for a long time. Employee retention credit, there's just a lot of misinformation out there and that, so those are the six areas I can expand down or talk about or ignore all six, whatever you want.
Jamie Nau: I'm curious, cause I know Adam's done a lot of speed dating in his life. I’m curious which one he thought was the cutest.
Adam Hale: The one, I mean obviously like the ERC is probably the most relevant right now. And I agree there's probably a lot of misinformation there. I think the one that's nearest and dearest to my heart is the R&D credit.
Because, like you said, a couple years back, they expanded that to a lot of internal use stuff. And I think that's whenever it became a little bit more advantageous for a lot of companies out there that are just doing regular stuff that they don't really think of that really qualifies.
So I think it opened a big door for those folks. So those are probably the two big, heavy hitters. Cost segregation–let's pick on cost segregation for a minute, and we can kind of circle back to the more popular ones there. But like on cost segregation, what's always kind of confused me a little bit is, I know it stinks to own a building and have to take that stuff over 39 years. Understood. But, then to be able to accelerate that depreciation in real time obviously has huge advantages on the front end, but, ultimately at the end of the day–I get it, time value of money, right?
But, depending upon the cost of the study and how that works, like where do you see those breakpoints where the cost benefit really makes sense since it's, you know, it's basically just pushing up the same benefit? It's not in addition to.
Randy Crabtree: Right. And what Adam is saying is, I got a commercial building. I'm going to write that off over 39 years. With cost seg, what we do is we accelerate a portion of that building to write it off today, rather than one 39th of it. Over 39 years, the benefit is the same.
But like Adam said, today money in my pocket today is worth a lot more than money in my pocket 39 years ago. But there is a point in time where it does make sense and doesn't make sense.
One is what's the size of the property that we're talking about. Did we invest $500,000 in this–whether it was a purchase or construction or remodel–to try to get a benefit out of it?
The dollar amount today is not that significant, probably a million dollars of a property and up is where it makes sense. And then one thing we do is when we're doing this, we do a free analysis, And I'm not selling, this is just in general telling you how this works. We do a free analysis because you don't know if the benefit's there.
And so. Let's do a benefit analysis, but on top of that, let's do an ROI. What's the return on investment for this? And if we get something where our fees are, you know our fees are 1/10th of the return, that's pretty low return on investment.
We really like to see five times. Our fee is the current net present value of the benefit. But you know, anything above 10 at least makes sense to look at 10 times our fees as the return of investment, but that's always the client’s or the tax preparer’s decisions.
We don't force anybody to do anything. So yeah, it's a million and up, and then, you know, ROI, we want pretty significant.
Adam Hale: Gotcha. And what are you typically finding that to be, that accelerant, what percentage of a million dollar-ish, if you just had to kind of average it out that you're able to accelerate?
Randy Crabtree: It depends on the property, but you know, let's say a high-end manufacturing facility, you could get up to 60-plus percent. If you're a, let's say just a storefront, you know, maybe it's 25-30%. So it just depends on the property. And then, it also depends, we went through some nice fixes to qualified improvement property.
It's just a way we can accelerate even more of a building that went through a nice fix about a year ago. And so that could increase. We just did one that was a two and a half million dollar medical practice. They just did a remodel of their entire medical office space.
And then, the first year we got about $2.3 million we were able to write off because of this rural qualified improvement property, which is improvements to the interior portion of a commercial building. So obviously, you know, the percentages could be all over the board, but on the average, you know, 30, 40%.
Adam Hale: Yeah.
Jamie Nau: So if you have commercial property, I think the key here is, if you want to talk to someone, make sure you're looking at the value obviously, and what the return on investment is. I think those are the two things to look for when you're talking to a professional. You don't want to get carried into something where you're paying a ton of fees and only getting one times that or two times; that's just not worth it. Make sure you’re getting some return on it.
Randy Crabtree: And then, Jamie, the holding period is important, too, because if you're going to sell this in two years, that probably makes no sense for cost seg. If you're going to hold it for the next 10 years plus, yeah, let's look at it. So that's a big deal as well.
Adam Hale: Yeah, that makes sense. And, just staying kind of on the real estate thing, that's where the energy-efficient initiatives really come in, right?
Randy Crabtree: Yeah. So, just to wrap up, the 179D is pretty cool, and everybody gets really excited about this free deduction for architects, engineers, general contractors, mechanical contractors.
If they can be shown that they're designing a government property. And what happens is if they're doing that and then meets the energy-efficiency requirements, the government entity could allocate this deduction to the designer.
So if you have an architect that just designed a 100,000 square foot university, government owned, they can get this deduction allocated, assuming that qualifies.
In that scenario, it could be up to $180,000 deduction. And now this architect is just going to have a $180,000 deduction on their tax return for money they didn't spend. So, you know, if they're in a 30% tax bracket, they've just, if my math is right, saved $54,000 in taxes for money they didn't spend.
So that's pretty cool. That's the one everyone gets excited about, but if you own a commercial building, you can also get this deduction; for you it’s just accelerated depreciation. Kind of like we talked about with cost seg, where we're going to accelerate it from 39 years, in this point, to a portion of it just written off in one year.
And so that's the 179D. That's probably about as much as you need to know on that, unless you guys want to go deeper.
Adam Hale: That's more; it's above my pay grade already. So you're probably good. So, if we didn't say that before, it's like, you know a lot of times I think the CPA firm community in general–I think doctors are better at this, but I'll call out lawyers, too–sometimes we have a tendency to just be generalists, and it's true. Yes.
We know a little bit about everything, but whenever it comes to some of this stuff, you really want somebody who specializes in it and knows these kinds of things, because there's all kinds things, whether it's running the cost benefit analysis or just understanding what's available and what's not, if you're going to go down this road just to maximize what you're doing, you really want to find a specialist.
You wouldn't go to the foot doctor to talk about your heart. That's the way some of this stuff is, too. And tax credits, these more advanced tax credits, it's not that your local preparer can't facilitate them, but whenever it comes to the analysis and preparation and making it audit-proof and everything, we always look for and work with a firm that specializes in these kinds of things.
Jamie Nau: We've all made that mistake before, when someone asks you what you do for a living, and you say I'm a CPA. You never know where that path is going to go down.
So like we've all made that mistake once. And we're like, nope. You never know what they're going to ask me when I tell them I’m a CPA.
Adam Hale: You know what they're going to ask you. It's like whenever you buy a truck, now you've got to move everybody.
When you’re a CPA, everybody asks, “Do you want to be the treasurer of the board?” So you get volunteered to do the books of everyone. It's like every time, if you knew CPAs, you’d know better than that.
Randy Crabtree: Everytime I get asked to be part of a board, I'm like, “All right, but I'm not going to be treasurer.” And then that's what they end up wanting me to be. So, you're right. Yeah.
So real quick, I want to touch on what you said because I grew up as a generalist in accounting and enjoyed it. Like you said, these things exist. But, I was never a specialist in anything. Then, 15 years ago I left. We merged our firm, and I decided to do something else.
And we started this current business, which is called Tri-Merit, and we do specialty work. Not that being a generalist isn't fun, but I've never had so much fun in my life being a specialist and being able to dig into small sections of the tax code, which to some people will probably sound pretty geeky, but to dig into small sections.
Adam Hale: Exactly you are right. I agree with that.
Randy Crabtree: But it's been fun. It has been fun because everything we do now, puts money back into businesses. So you can't beat that.
Adam Hale: Shifting gears, we talked about the hard assets with the building and the cost seg, and the energy pieces, but the rest of them really revolved around humans and people–whether we're talking about like the ERC credit, which we can kind of dive into. But I think, and even the R&D credit, obviously that's a lot of that for at least with the clients that we work with, that's a lot of people hours going into that, there's not always a ton of hard costs going into that.
But before we jump into that, the one that I don't think a whole lot of people think about outside of maybe the restaurant industry, I think this is kind of a common thing that they think about often is the work opportunity tax credit. You mind explaining a little bit about what that is and how that works?
Randy Crabtree: Yeah. Well, just real high level, you want to think of it as a new hire credit. Am I hiring new individuals? If so, let's see if they meet requirements to get a credit. And people are used to employee credits with the employee retention credit right now; think of it that somewhat similar–I'm going to get credit for not just retaining somebody, but for hiring somebody now.
To get this credit, you have to hire somebody that meets certain requirements set out–either a demographic requirement or a geographic requirement. And they hire somebody that lives in a certain area. And it's usually, like you say, restaurants; it's usually a higher turnover, probably lower paid position that becomes eligible for the credit.
But you hire somebody on food stamps. They're potentially qualified, somebody that's been long-term unemployed, which is six months, which you probably have a lot of that still out there right now, just from what we were going through. So someone was out of work for six months. You hire them, they can qualify for this.
There's a completely separate category for veterans groups; if you hire a veteran you can get credits. And the credit can be anywhere from $2,400 to 9,600 per employee. From a credit standpoint, you don't want to turn over, but you want to at least have a decent amount of new hires a year, because if we analyze 50 employees, maybe five qualify. And if we've got these five, maybe we got somewhere from between a $10,000–$40,000 credit. And then it starts to be real money.
Adam Hale: Yeah.
Jamie Nau: Correct me if I'm wrong, but I think this is a key on a lot of these credits is making sure that you're keeping good documentation, right? How many new hires did you have? What are their qualifications? What are their cases? What are their situations?
That way, you can come to your tax preparer and be like, “Hey, this is who we hired this year. Do you think there's any credits you might be eligible for?”
Randy Crabtree: You're right on it. Other than that this is not an end-of-the-year thing, unfortunately. This is very time restrictive, and you have to submit the new hires to the state.
The state administers it for the federal government. You have to submit the information within 28 days of somebody being hired. And so that's the biggest thing. And then, unfortunately, you don't know for a year, maybe two years, some places longer, if the state says, “yes, they qualify.”
But you start the process; you start getting these submitted. And then, there's a form where you can ask these questions, which it's completely legal to ask, and then submit to the state. But you're getting into some personal information when you're asking these questions. So yes, time restrictive.
Adam: Yep. Yeah. I mean, I know the payroll companies will, a lot of times, get involved with these, especially with restaurants and things of that nature.
It's also people with disabilities, right? So it's always been one of those things where I don't know everything that you read about and know about HR, it seems like it's everything that you would need to do to complete this piece. And I know some people will actually come and bring it up and say, “Hey, by the way, I qualify.”
And they might already know that they pre-qualify for these opportunities whenever they come to you. But aside from that, it just seems like not typically what you would put on your questionnaire in terms of, are you disabled? Were you on your stamps? You know? Obviously that makes a little bit of a barrier for some of this stuff, but, like you said, there's also a threshold of wage, right?
To where these things make sense. Because it's not for somebody that you're hiring that makes a couple of hundred thousand dollars or what the cutoff there?
Randy Crabtree: So it's just based on somebody who has to work for 120 hours before they're qualified, and once they hit the 120 hour threshold, then you get a portion of their salary.
Honestly we have somebody that heads up that team, and I'm going to get the math wrong on this, but for up to 600 hours, and now we've got full credit for them. So really for higher-paid individuals you can get it; you're just not going to have a lot of new hires at $200,000 a year.
And that's why, typically, it's the fast food restaurants. You see this just because there's more turnover, and there's more potential eligibility. But, it could be that I could hire a veteran that spent the last five years doing high-tech work for the government and, maybe they have some qualification based on being a veteran that they still qualify. So we could look at it, but that's not the common user of it. You are correct.
Adam Hale: Okay. So that's on the one side. And then, which one do we want to tackle here first? Do we want to go for ERC or R&D?
Randy Crabtree: Let's end with R&D, I’m saying.
Adam Hale: Okay.
Jamie Nau: That’s my vote, too.
Adam Hale: So make everybody make everybody wait and think about that one. Okay. So you're saying common misconceptions and believe me, I agree with you. Cause I remember researching that one.
Honestly, for me, it was a good get-out-of-jail-free card because we took the PPP loan. You know what I mean? Whenever you did the math, the PPP loan was always way more advantageous than doing the ERC credits.
And then, the government originally came out and said, pick one, but you can't do both. We ran the analysis a bunch of times. I don't have to deal with payroll. I don't have to deal with all that mess. And then they came out and said, you can do both.
And so then, I go and do all these calculations, and figure this stuff out again. Let's go find somebody that specializes in this. I know for those folks who do it all day long, it's not that difficult, but for the rest of us going thorough and thinking about amending payroll tax forms and all those kinds of things, it’s really on the bottom list of anything that I could possibly imagine I'd want to do.
So with that awesome intro into ERC, why don't you explain to everybody how awesome it is and why they should be thinking about it or some of the common misconceptions?
Randy Crabtree: Yeah, sure. And so I had the opposite reaction you did when that changed.
I just became intrigued with it, and I had no plans to even make this a service offering for us. I think January 7, 2021, I started reading the changes that came out of the Consolidated Appropriation Act, which has really updated this. And I see Jamie's already getting bored here.
Jamie Nau: I need to open a window.
Randy Crabtree: But it was just amazing that now the PPP, you could do both, like you said, Adam, and so that's great.
There was a misconception at the beginning about, “Hey, well, if I took the PPP, I'm not doing the ERC that changed in the CAA. But then, I used that period for PPP forgiveness so that period isn't available for ERC.”
That is wrong.
It depends on how you did forgiveness, but that's not even the misconception that I’m concerned about because I can fix all that stuff. I can work around that stuff.
The misconceptions are, there's a lot of ERCs being taken that I don't believe exist, and that's where I can get on my soapbox because not everybody in the country qualifies for the employee retention credit.
It doesn't happen. It is not out there. There's plenty of companies that qualify that haven't taken advantage of it, and there’s two ways to do that. There's a safe harbor. I had a significant drop in revenue in any quarter in 2020 or 2021 and a significant-defined difference in each quarter, but I had a significant drop.
Okay. I qualify. Boom, safe harbor. No questions asked. I don't even have to prove that the drop was due to COVID. I just have to show that I had a drop in revenue compared to 2019; everything's compared to 2019. The other issue is then, if I don't have this significant drop, can I still qualify? Some people think, well, no, I didn't have a drop.
Well, you can, if you can show that a government mandate affected your ability to conduct business in some manner. And I can go deep into that, which we're not going to do today.
Adam Hale: Why not? Jamie wants to hear more about that. He really wants to hear more about that. Maybe you guys can do that offline.
Randy Crabtree: Yea, we can do that offline, which is fine.
That's where people are missing, but that's also where people are qualifying companies that don't qualify because, “Oh, if you had to wear a mask, do you qualify?”
No, that's not the case. So you have to really dig deep and show that there's an effect before you qualify, but that the numbers could be huge.
You could get as much as $26,000 per employee, if you qualify the entire period. And it’s just a refund check. So it's a big deal. It's worth looking at.
Adam Hale: We've had some clients do well with the ERC credits. And so as a baseline, you know interruptions aside as a baseline, the way I always, and correct me if I'm wrong, the way I always kind of looked at it is, as like the first qualifier for me was: Did the client qualify for the second round of PPP?
If they qualified for the second round of PPP, then you knew they had a significant drop in revenue. Because that was kind of the bar that was set for the second round of PPP. So that was kind of like always my first thing; if they didn't qualify for the second round of PPP, that's whenever I'd usually go down the road, that was my decision tree.
Initially whenever I was consulting clients before I'd bring in somebody to actually put the numbers together, then I would always be like, okay, if you didn't, did you have an interruption? Were you mandated to close? And then the one that was, I was probably always a little sticky on or was not as up to speed on, was the supply chain issues that maybe you could argue that the supply chain, maybe not directly government mandate to close down, but some supply chain issues that you were kind of impacted.
I know that one can kind of be a little bit of a gray area, so we would have those conversations. And as soon as we had those conversations, and we tried to be as conservative as possible on those, if they went anywhere, then we would kick it over to a professional, like you, to be able to articulate it and, and calculate it and see if it made sense. And then, same way with the round to PPP. Does that logic tree sound reasonable?
Randy Crabtree: I'd say it's reasonable that the drop in 2020 was 50% for safe harbor. So 25% drop qualified you for round two of PPP, so you know there was an effect. You may not have met safe harbor rules, but something happened. Why did it drop?
And that's where you start to dig deeper. Why did my revenue drop 25%? What caused that? Was it a lack of demand? Which, the IRS argues does not qualify you. I don’t completely agree with that.
It just depends on situations or was it that you were shut down or your suppliers were shutting?
Supply chain, just so you know, that's a tough one. Because a lot of the supply chain issue was just a demand issue. Demand went way up in our country, and, because of that, supplies were harder to get. People argue, “Ok, so supply chain, I couldn't get things, so do I qualify for that?” You have to dig deeper than that. It has to be a COVID effect to do that..
Adam: Oh, gotcha. That makes a lot of sense. Whenever we're kind of talking through that with the ERC though just before we leave that topic, like you said, there is a lot of work that you kind of have to do there, calculate if there was that drop and then you're going to get a certain amount per employee.
So can't double dip in your PPP money or PPP round two money. So you have that little offset; they extended the time frame, so a lot of folks did actually end up qualifying for it. And then typically the way that works, whenever you find a firm that will work with you on that stuff, they'll do all the amendments for you, right? As part of their fee. And then what's a typical fee that a client should expect to pay for that type of service?
Randy Crabtree: A good estimate is maybe on the high end, although I’ve seen it higher than this, but I think it should be 15% of your credit for a smaller company and maybe going down to 10% or less on the larger company of the credit.
You just saved $100,000; your fees should probably be around $15,000 for that tax savings.
Adam Hale: Okay. Cause for that one, they did allow it to be contingency based, right?
Randy Crabtree: Yeah, that's what we feel. Most people are charging that way. There are still probably people that may think you can't, but it is amended returns, and there is a carve out for amended returns. So we should be all right.
Adam Hale: All right. Here's the big lead up, Jamie, take us home with all your R&D questions.
Jamie Nau: All right. Let's dive into R&D. So I know a lot of our clients are in the digital space and in the agency world, and there's a lot of hours tracking and that goes into the R&D credit.
And I've had a lot of clients come in and say, “Hey, tell me more about this.”
And when I said, “Okay, let's bring a tax guy in to give you the specifics and qualifications and then once we get to those qualifications, we know what we need to keep track of.”
So let's, let's dive into that a little bit.
Randy Crabtree: This is an extremely interesting area. I get excited about this stuff because major things just changed in January of 2022 on this. And so we might want to touch on that a little bit, but to give you the definition and how these agencies work and what we see.
Real quick. R&D tax credit is different from what it probably brings up in your mind. It's not white lab coats. It's not developing a time machine. It is, are we doing it, developing something newer and improved? And that the code says new or improved product process, technique, formula invention, or software; software is specifically called out as a qualified activity in the code.
And then, if it's software based, are we programming something? If we are, that's an activity that qualifies. Are we testing a new program? Are we developing new modules? Are we developing new components within these modules, new capabilities?
That's all qualified activity for research and development tax credit. And that is the quickest definition of R&D I've ever given. Do you want me to expand on that at all?
Adam Hale: Yeah, I think that's the biggest misconception; everybody thinks that you're building the time machine. So it really is about just improving even process internally.
It doesn't have to be a physical thing, which I think is really unique, and it doesn't have to be something that you plan on selling because, again, improving a process, it can be something internal, which they came out with a few years ago, and we talked about a little bit earlier.
But I think it was a big eye-opener and a big change for a lot of folks in the space that we work in. But then, kind of moving that forward, what were the changes then in 2022 that people need to know about?
Randy Crabtree: This is big because if you've taken the credit before, you know one way of documenting it and one way of submitting it, and the way that the credit has been submitted in the past has always been file form 67/65, which is the tax code that you put the R&D tax credit on.
That is still acceptable going forward on currently filed returns. But if you haven't taken the credit and you want to go back and see if you have past credits that you haven't captured, a lot of times in software development, people aren't thinking it's R&D, so we go into an agency or wherever it is, a CPA firm that develops software and they weren't even think about it as an R&D, and all of a sudden, now it's an R&D project that they did three years ago.
To capture that, we have to amend that tax return. The credit has to be taken in the year the activities incurred. And so to amend going forward, this is the big change. The IRS surprised us October 15th and said, “Hey, we got new rules coming out for amending.”
And they didn't even specifically say “amending;” everybody thought they were talking about the amended returns, but we weren't sure. If you were filing an R&D tax credit, these rules are gonna change. They told us it was going to go into effect January 10, 2022.
On January 3, 2022, they clarified everything for us. And the bottom line is, if we're going to file a tax return, an amended tax return to claim an R&D tax credit, we have to now show every business component the credit was based on.
So, this module we just programmed, that's a business component; now, who was working on this module. That's what they want to know. Who were the individuals in the company that were programming? testing?
What were the research activities each individual was doing on each business component? Were they trying to discover or overcome? What were the uncertainties that each individual is working on? This is documentation that we've always done but never had to submit.
Now, going forward, when you do this, you have to submit this additional information. We have a one-year grace period where if we do it wrong, they're going to give us 45 days to correct it. And then after this one year, who knows what happens.
I wouldn't be surprised that if this works well for the IRS, they will extend this to all R&D tax credits finally. That's just a guess on my part, but I think we're kind of in a test phase to see if we need to do this going forward. Don't let people get scared about that. This is how you're supposed to document the credit anyways. It's just a matter of, you'd never had to submit it before.
Adam Hale: That's only with the amendments? That's not with current year stuff?
Randy Crabtree: Correct. Yeah.
Adam Hale: Which is strange because I guess it's just another hurdle because we all know the IRS is pretty strapped for talent these days.
Jamie Nau: They’re trying to hire all these agents.
Adam Hale: They're going to be reading through a bunch of R&D literature. But who knows. I guess they’re trying to make the hurdle a little bit higher for people to go back and stretch for it. Not the not-so-compliant folks, but as you mentioned, that's just kind of par for the course.
Anyway, you should already have that study. And again, that's why, rather than going to just the preparer down the street, whenever you go to a specialist, they have a lot of these forms and a lot of this, how this should be, laid out; it's kind of a template so they can fill in the blanks and give you a real professional-looking document that you don't have any problems submitting to the IRS.
Randy Crabtree: Can I explain one more major change that kicked in this year with R&D expenses? And I don't know if you guys are familiar with this or not, but the tax cut and jobs act defined how we treat R&D expenses on a tax standpoint. We've always traditionally, almost every client has deducted R&D expenses as they've occurred them.
They don't even know they made this election. They had some R&D expenses that were hidden in salaries and wages. They deducted it. They made an election to expense it starting January 1, 2022. You can't do that any longer.
You now have to capitalize all your R&D expenses and amortize them. If it's a U.S. expense, amortize it over five years. If it's a non-U.S. R&D expense, you have to amortize that over 15 years. So all of a sudden, a small business’s tax bill is potentially going to skyrocket; a $3 million software development company could very well have $2 million of R&D expenses.
Now they can't deduct that $2 million in one year. They're going to actually own the first year. They're actually only going to get 10%. So they're going to deduct $200,000 the first year, rather than the $2 million they normally would have, increasing their taxable income by $1.8 million. That's a big change.
Adam Hale: You're saying they're supposed to do that regardless if they think about doing an R&D. So it's almost forcing everybody to kind of think about an R&D tax credit because you're saying that’s not if you file the R&D tax credit; you're saying you have nothing to do with the credit.
Randy Crabtree: Right.
Adam Hale: So if the IRS comes knocking on your door and just says, “Hey, we determined that you were doing a lot of R&D activities.”
They could potentially capitalize some of your expenses, which means you're deferring them. And then you owe a bunch of money in tax because you didn't. And you can't just click a button and opt out of that, huh?
Randy Crabtree: No. Now, I think we may have mentioned the Build Back Better bill earlier, or at least pre-gaming we did. I'm not sure. In there, they were going to kick this down the road until 2026 and delay this even further. You know, when it was originally defined, the tax cuts and jobs act was delayed for four years.
This was going to delay it again; obviously, that hasn't passed. We're very hopeful this will get delayed, but honestly, we know we're coming up to quarter estimates. I think we need to take this into account when we're doing first quarter estimates for taxpayers, because this is a big deal. This can increase taxes quite a bit.
Jamie Nau: For sure. Cool. Well, we are right up against time. So I think we've all learned something about Adam's dating style he's interested in. He's not going to stop at one or two. He's going to go into all six, but I think that was very helpful for our listeners to speed date the six topics here.
Hopefully people understand, I think the biggest thing is to make sure you go to a specialist; you want to make sure you go to someone who understands, not just a tax preparer down the street. Any other final thoughts from you, Adam?
Adam Hale: No, that's probably the most important; seek somebody out like Randy, who does this. That's his day job, and that's all he does.
He'll be able to go a mile deep on these situations in these particular instances. And that's who you want in your corner whenever you're going down this road.
Jamie Nau: How about you, Randy? What's your final thought for our listeners?
Randy Crabtree: Yeah. Well, I agree with Adam. It's very important to look at all this stuff and there are tax saving opportunities. Seek somebody out, but be careful and make sure that you actually qualify for these things before you're taking advantage of them because that's what I've seen not only in ERC, I've seen at other places as well.
I just want to thank you guys. I had a great time. This was a different topic than we originally thought about; hopefully it was good for you, but if we ever want to talk about building a niche practice, I'm extremely passionate about that as well.