Phase 1: Generating an Estimate

    Because R&D Credits are typically among the most valuable incentives available to a taxpayer, it is important that they are properly vetted and scoped. Phase 1 is the means to do this, and has two goals:

  • Ensure that the taxpayer is not barred from taking the credit; and
  • To confirm the true value of the credit, and who will receive it.


Most every industry can generate a credit of some type. Please note the estimator here: Estimator. This produces a basic estimate, used to determine if pursuing a credit is useful at all. Once past that, Phase 1 expands the detail of this estimate considerably. The first determination here is to locate any ‘barriers' to capturing the credit that could lower or eliminate utilization. These barriers include:

  • Tentative Minimum Tax ("TMT"). TMT is probably the most important barrier to the R&D Credit. Conceptually, TMT is a minimum level of tax that all companies must pay, and cannot typically be offset. In some instances, it is possible for this to completely block the credit from being utilized in a given year.

  • Passive Shareholders. Knowing if a shareholder's equity is classified as "passive" is extremely important. Passive shareholders can be limited or blocked from taking the R&D Credit themselves. Confirming the consequences of passive ownership is mandatory.

  • Funded Research. This is an exclusion to the R&D Credit related to who is most at risk for developing the research. This is a very strict analysis based exclusively on the language of the contracts responsible for developing a product. Ascertaining who has "rights" to the technology, and is "at risk" for payment, can determine who can receive the credit.

Each of these concepts can be readily answered by one or more documents:

  • Tax Returns. Tentative Minimum Tax, and its effect on the R&D Credit, is a question readily determined with tax returns. In most cases, a Form 3800 "General Business Credit," is prepared by every taxpayer, specifically lining up how much credit can be taken. In this regard, obtaining complete tax returns is critical to determining if there is a barrier to the credit.

  • Individual Returns. The "active" / "passive" determination for an investment can determine whether or not a shareholder's credit is usable. Each tax return contains schedules which denote if an investment is passive or active. So again, ensuring that we receive complete tax returns is credit to determining barriers to a credit.

  • Service Contracts. Determining if qualified activity is "funded" is based on a bright-line test of a company's service agreements. By evaluating two legal concepts referred to as "rights" and "risk," it is possible to readily determine if a company can take the R&D Credit. This applies both to companies which the taxpayer works for, or works for the taxpayer.

The essence of this is that questions can be determined with two sets of data: Tax Returns and Contracts:

Accordingly, anyone going through a Phase 1 should be ready to pull Tax Returns and engagements.


Once we know that the taxpayer can take a credit at some level, it is critical to determine the maximum credit and scope of work. This is an estimation exercise which is typically run in one of two ways:

  • Data Driven Approach

    The best approach to Phase 1 is to let existing data inform the credit in every possible way. Our world-class analytics and reporting systems allow us to calculate the credit with great certainty from original data sources. By preparing a detailed a financial ‘history,' the taxpayer can save huge amounts of time during the interview process.

  • Summary Data

    The conventional way to developing the credit is to use detailed summary schedules / reports, and interviews to distill the qualified activity. By summarizing the activity from critical cost centers, and providing extremely knowledgeable managers, these interviews can be run quickly and with minimal effort.

The goal is to generate relatively final credits in the estimation phase. Documents and materials to each side are as follows:

  • Data Driven Approach

    • Financial Database – SQL, Quickbooks, etc…
    • Project Database – Manufacturing ‘job' records, ANSI engineering modifications list, etc…
    • Time Tracking Data – from time tracking module.
  • Summary Data

    • Trial Balance and General Ledger detail for select accounts
    • Project accounting/tracking summaries
    • Third-party labor costing reports and/or invoices
    • Payroll with Box 1, W-2 amounts

The more complete and relevant the records, the more accurate the estimate.

Practice Note

The credit has complex calculation mechanics, meaning that it is important to get documents for more than just the year under analysis. Note that for any given year, you have to compare it to a "Base Amount," which is made from the prior three years:

In addition, it could be that you have four open years. The rule is that you can generate a credit for any "open" years. Open years typically means any return filed within three years. Accordingly, it is possible to need all of the tax returns for four years, and all of the financial data for up to seven years:

What is important about this is not that it must all be generated immediately. It is possible to generate a highly accurate estimate with some portion of this data, shy of it all. This is common. That said, it behooves everyone to.