A friend in the IRS: Two engineer-based tax strategies to immediately impact your bottom line

If you own a building or perform R&D, you may be entitled to tax credits. Here’s how to get them.—Bryan Ray

Taxes. It’s one of two things in life that is certain along with death, according to Ben Franklin. While we certainly have to pay taxes, there is no law that says we have to leave a tip for Uncle Sam. I’m going to share two engineer-based tax strategies that should be used by injection molders and other industrial companies to improve their bottom line.

If you own your building, read on. There is an increasingly popular engineer-based tax study you can have performed that accelerates depreciation on the “guts” of your building. In fact, it should be used on every piece of commercial real estate after the transaction is completed.

What am I talking about? Cost segregation studies. What does it mean for you? It reduces the amount of tax you owe today and keeps more cash in your pocket. Often it is a six-figure benefit to the property owner. The average benefit to the property owner is approximately $150,000 for every $1 million that is reclassified. This, of course, varies depending on the individual situation. Many commercial properties can reclassify 20-40% of their cost basis.

How does it work? Cost segregation studies, when done properly, will have a qualified engineer come onsite to identify, segregate, and document various parts of the building for faster depreciation. You’re probably thinking, “Shouldn’t my accountant do that?” The answer is no, although they will recommend the study if they’re familiar with it. CPAs are masters of their craft, but most don’t have the engineering expertise to properly identify all qualified items within a building. The electrical, plumbing, and mechanical systems, among many other items that make the building run, are not within their realm of expertise. It makes sense to bring in an expert so you don’t leave money on the table. A good CPA recognizes this.

At this point, you may be wondering what it takes to qualify.
• If your building was purchased after 1987 and you’re currently paying income taxes, you have passed the first two steps.
• The next qualifier is based on purchase price or the dollar amount put into a renovation/building improvement. Most firms that perform the cost segregation study want cost basis or purchase price of more than $650,000 and some require at least a $1 million purchase price (excluding land value). As for renovation costs, documenting more than $350,000 will make the study worthwhile for most firms.

Cost segregation studies are not new, but many business owners are unaware of their benefits and the means to accomplish them. The IRS supports the methodology of using the detailed, engineer-based approach. Building owners should use it so every detail that can be claimed is claimed. The CPA should recommend it because it transfers liability to the engineering firm, lowers the chance of audit, and is extremely cost effective for you, the client.

Just what is R&D?

Another tax strategy that you may qualify for as an injection molder is the research and development tax credit. You may be thinking, “We don’t do R&D.” That is precisely the thought that misses the credit. Many relate R&D to owning patents or even envision a person dressed in a white lab coat. We are far from those days. In 2001, the definition of what qualifies for the credit was expanded as incentive to keep jobs here in the USA. That’s great news for many small and medium businesses throughout the country.

The majority of the credit has traditionally gone to large conglomerates with dedicated research and development teams. Until recently, they have been the only ones taking the credit because they hired the large consulting or accounting firms with staff engineers qualified to conduct the study. Some staff engineers have left to start their own firms and have made the credit more attainable and affordable to the small and medium-sized companies.

If your payroll is on the high side of $1 million, it is certainly worth looking into this credit as it is heavily based on payroll. The other qualified costs include cost of supplies and contract research. For instance, paying a consultant/expert to come in and improve physical business processes can qualify. The credit should be calculated every year that qualifying processes take place. The credit even allows you to look back on three prior open years to take past credits that were missed.

For example, an injection molding company that has $2 million in annual payroll would earn approximately $26,000/year in R&D tax credits, or a cumulative amount of $104,000 for all four years. The prior years (three open years result in cash back/refund from the IRS) and the current year is a dollar-for-dollar reduction in taxable liability. The credit can also be carried forward for 20 years.

It should be noted that the definition of what qualifies is very technical and requires specialized engineers to identify and document the qualifying processes. The supporting documentation is what you pay for. Similar to the cost segregation studies, the chance of an audit goes up if you apply for this credit and the documentation is not collected by a qualified specialist. And if there were an audit, you would want all the documentation possible to back up the claims.

If you’re currently working with a CPA firm, consider asking them if they have an engineering partner for these two different studies. Just make sure their partners provide audit defense as part of the package in order to protect everyone involved. This can also act as an indicator of experience and confidence in their work. Both cost segregation studies for your property and R&D credits are cost effective and provide immediate impact to the bottom line. It could significantly pad your wallet come tax time.

Author Bryan Ray ([email protected]) is a senior advisor with Core Solutions Group, a national cost management firm specializing in tax recovery and cost reduction techniques for small to medium-sized businesses. You can contact him for a free analysis.