R&D Tax Credits For Dentists: Do They Qualify? —featuring Andre Shevchuck

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To another episode of the Dental Boardroom, it's Wes Reed coming at you. And today on the show I have a highly relevant topic based on the questions I get from my dental clients all the time here at Practice cfo. And it is on the R and D tax credit, which many of my clients know it as simply the R and D tax credit, but more formally it is the RD research and development tax credit. And on the show I have an expert who spends most of his professional life on the subject of evaluating, calculating, filing for the R and D tax credit. And his name is Andrej Shevchuk. Andre, welcome to the Dental Boardroom podcast.

Wes, thank you very much for having me.

I am excited for this one because I want to try to clarify to dentists what the R and D tax credit is, is, and whether or not they qualify for the R and D tax credit. Let's start off by just setting the framework for who you are and the authority that you have on this subject to make that very clear. Give us your background as a specialist in this area.

Yeah, happy to. So my background is that I started my career out of college at a big four accounting firm and found my way to R and D credit consulting quickly thereafter. So starting around 2007, I was solely focused in R and D tax credits and servicing our clients that help them to identify, document and defend their tax credit claims. Since then, I've been working with hundreds of clients, some of the most well known companies on earth, and going down to brand new startup companies and everywhere in between. Currently I am a partner at BPM, which is a top 40 public accounting firm. I'm based here in the Bay Area, covering our San Francisco and Silicon Valley regions.

Yeah, Andre and I met each other at a firm called Moss Adams way back in the day, this was 2007 or so, and I was in their wealth management arm and we, we shared an office, it was split. And you and I spent a lot of time together at the time and you'd always sort of be sometimes on site or with clients and you'd come back and I always was wondering, is there that much depth to this research and tax credit? And I've come to learn that there is a lot going on with research and development tax credit. It's a big credit and therefore a lot of businesses want to qualify for this credit. And it's not black and white. I mean, a lot of the IRS tax code attempts to be black and white. It's basically check the boxes. But in reality there's so much interpretability on the rules around the research and development tax credit. Let's now pivot into what it is. Specifically, I will give a very layman's explanation of it, and then I want you to give the real explanation of it. The way that I always define the research and development tax credit is that the government attempts to incentivize businesses for taking risks, financially and otherwise, to innovate something new. Innovate some efficiency, some new product that improves our economy. Our economy is very much dependent on constant innovation. This is why tech has been so influential on our stock market, is because tech is kind of the epitome of innovation. It's created so many, so many efficiencies for us. And we see this going on right now with AI as well, and companies in tech, in biotech, in automotive, in renewable energies. In pretty much every field, there's somebody who's attempting to introduce some new technology, some new process so that their company, and possibly likely the industry as a whole is improved because of that, and ultimately that consumers and our economy is improved by that. So it's this carrot to the. To motivate innovation. And dentists have attempted to apply this, saying that we are doing a new process in our office, or we're innovating a new way of doing a restorative treatment or some other dental treatment, and therefore we're going to apply for the research and development tax credit. And what happens when they do that is they would deduct their normal expenses for supplies, equipment, labor, facility, things like that, just like any everyday expense. But then they would sort of double dip in a way, and they would get a credit for those same expenses that they were using to create this new thing in their practice, which may or may not be the right way to do it according to the actual calculations. So that's my attempt, Andre, at explaining it. Why don't you go ahead and formalize that a bit for me?

Yeah. So your impression is not uncommon. Right. So oftentimes when we think of R and D, we think of people in lab coats with beakers or scientists blowing stuff up. But what it actually says in a tax code is that there is a four part test that's defined in the actual code, section 41, and that dictates whether or not a project or an effort is qualified. And that four part test is simply that your efforts have to be technical in nature. So relying on engineering, computer science, physical science, or biology would satisfy that technical nature test. The second test says that you have to have what they call a Permitted purpose, which is your activities are in an attempt to develop or improve a new or existing business component in terms of its functionality, performance, reliability or quality. And a business component is defined as any product, process, technique, formula or invention. So your idea of creating something new is not incorrect, but it also could be something that's existing.

The third test is kind of the key to R and D and the definition of what we consider what R and D is. And that that test says that when you're attempting to develop or improve your business component, there has to be an element of technical uncertainties or challenges that you're faced with in regards to your capability or the method you're going to use, or trying to find the most appropriate design to achieve your goal. And then the fourth test goes really closely with the third test and it just says that in your attempt to overcome those challenges, there has to be an evidence of what they call a process of experimentation or testing. And this process of experimentation is kind of what they look to when you're looking to your activities. So in a process of experimentation or kind of like the scientific method, you start with hypothesis and identifying ideas and concepts, solidifying those concepts and making them into requirements or technical specifications, taking those specs and trying to create a prototype or a model or simulation and testing and retesting in that effort to overcome your challenges would in fact be that process of experimentation. So these four part test is applied to that business component or project level to determine whether or not you're qualified. So that's the kind of the black and white of it. But as you stated, this is one of the least black and white areas in the tax code. It's so great to interpret how these rules apply to what you're doing, that a lot of different types of industries and companies could take advantage of the credit. And that was intentional. It was meant to be vague this way so that it wasn't limited to one particular industry like drug development or defense or manufacturing. It was open to everybody.

So I just want to reiterate those four. Number one, it has to be technical in nature. So what dentists do is very technical. It's within the sciences, it's within the healthcare. I think that box would be checked. Number two is it has to be something new. It has to be a new process, product, invention. It has to be something that didn't exist already in the way that the business was being run, the way that treatments were being done, the way technology was being used. It has to be something new.

Well, it's better to Think of that as they call it, the permitted purpose. And it's to develop or improve a business component. So it's easier to think of it as a product or a process. Right. You're improving a product or you're improving a process.

Tell me number three again.

Number three is the key to R and D and that's when you're attempting to develop or improve that component. You have to demonstrate that you're technically uncertain of your ability to, or the method or the appropriate design that you're going to use. So you kind of have these unknowns or challenges.

I think that right there is the one that I often. Well, the two that I mainly think of is that this permitted purpose. So number two, that this has to be something new. And you know, in my head is are you inventing or innovating something new? I mean it's, that's in my head it's always been that simple. Are you creating something new, fundamentally new, not just the way you do an impression on a crown or a tooth or whatever, but something fundamentally new. And then number two is, are you at risk financially of putting money into that thing and never seeing a return on that money? Is my simple way of viewing that uncertainty aligned with that?

Number three, financial risk isn't really, it's not in the code. Right. So you're looking at the black and white letters of the code. Financial risk isn't there. But I think what you're getting at is that when you look at technical uncertainty, you talk about some things that are activities that are routine. You do this every day. You're totally certain that you know how to do it versus things that like I'm going to develop a whole new way of doing this process. And this, maybe I'm unpatented, maybe it's my trademark thing. I'm going to, it's totally new and I'm going to submit a peer reviewed paper about it or whatever. Right. We can talk through examples. But I think you mentioned before the intent of this credit in the 1980s. This is when the credit became available in the Reagan administration, 1981 and back then among the OECD countries, this was the first type of incentive that offered a tax credit for R and D. And what we were facing this as a country was a lot of competition from Germany in terms of automotive and a lot of competition from Japan and from electronics. And we were falling behind. And so this is their way to incentivize innovation and, and competitiveness and to give people a tax break for doing these types of activities. So that was the intent. And back then, if you look at a lot of the examples that they give you, a lot of them are kind of related to like manufacturing processes or they give examples of trains or airplane, or now they have software examples. But in effect, it's to develop or improve a business component. When you say new, I mean, it's a lot of times a misconception because you think of like the iPhone, right? The, the iPhone isn't necessarily new, but every year there's a lot of improvements made to it. So that is still continuing to be.

R and D. I am not exactly precise in that being correct, but there is something there that would make sense. Yeah, it's always hard for me to explain it to a dentist because I don't know the code like you do. And I'm trying to distill it down to something that they can understand.

I think the best way to describe it is like routine versus experimental.

Okay, that's my new word. Routine versus experimental. And then of course, the evidence of testing, meaning that you're trying something over and over and over with uncertain results, and you're trying to discover something new based on the outcome of that testing. All right, now what do you think that a lot of these R and D sales people that are approaching dentists and claiming that they are eligible for the credit, what do you think is their grounds for making that assertion?

Well, as we've called out here in describing these very vague terminology about what qualifies, what doesn't, I think it gives a lot of opportunity for people to sell or market this tax credit and say, well, look, if you're looking at these very simple definitions, don't you think you qualify? And it sounds too good to be true or like, yeah, I do some of this stuff. And suddenly someone's going to offer you a contingent fee and they're going to say, we're going to get you this big credit. We won't get paid unless, you know, unless you get this credit and satisfy it on your tax return. So that's kind of a hard bargain to pass up. It's like, I'm going to give you a hundred dollar bill if you give me $20. The R& D credit is known to be a very aggressive space in terms of taking tax positions. In fact, on the corporate tax return, there's something called your uncertain tax position forms. And of those forms, the number one most uncertain tax position for taxpayers is their transfer pricing, which is a kind of international tax play. Number two is the R and D credit.

So there's probably a lot of industries trying to take advantage of the R and D tax credit. It's probably not unique to dental that it's a gray area or an industry where there's probably a lot of abuse around it. It is very hard if somebody comes to you and basically offers you free money. I think what happens though is they downplay the risk or claim that there is no risk. So what is the risk to a dentist who takes, let's say, 150, $200,000 R&D tax credit for going back two, three years, amending the tax returns to take advantage of the credit based on the calculations done and the report done by that R and D consulting company, they file it, they get the money that usually the IRS will just sort of rubber stamp these amendments. It comes in and then there's a period where it can be audited and then it can be taken back with penalty. And is that the process that you're generally seeing is the IRS basically just remits the credit back in a check and then.

If it's going to be questioned by the irs, they'll do it after the fact?

Yes. So there's a lot to unpack there. But I could say for certain that the IRS environment is very, very contentious around the R and D credit. They are aware there's a lot of people who are taking aggressive positions and they're using different techniques to combat some of these aggressive positions. So they have like chief counsel memorandums or technical advice, or they have court cases that come out that give the IRS some tools to sort of combat. So there's a three year statute of limitations. That's how long the IRS can look at your return before that return can't be amended or relooked, looked at again. And some people are banking on that three year statute lapsing and there would be no exam. So the credit is solidified in that return. So if you are to be examined, the IRS has, like I said, a lot of tools in their bag to discredit your claim. And one of those is just the documentation requirements. You have to have substantial documentation to support your credit claim and showcase that you meet this four part test criteria and, and that your activities were in fact valid.

Okay, so how often is the IRS preventing the submitter of the R and D tax credit from ever even getting their cash in the first place as opposed to coming back in during those three years to discredit it and get their money back?

There's no goaltending there. There's no, there's no, there's no preventative measure to stop it. It's sort of reactive. Right. Other countries have similar, very similar credits. Canada, Australia, uk, all very similar types of incentives. So some countries have an application process where you're kind of looking at it up front and kind of goaltending that. Here it's much more reactive. And as we know, the IRS has had limited resources for a really long time and they're trying to go after people who are being aggressive or for very large claims. They spend a lot of time focused on companies who have huge R and D credit claims. And they can, they're. The value of that audit is much greater. Right. Their roi, if they were to discredit a, you know, I've worked on some claims that are in the hundreds of millions of dollars and if they can discredit that claim by 20%, that's a huge ROI for them. So they're not always going after some smaller claims. And these aggressive promoters know that. And so they're kind of banking on the IRS roulette. Right. So they think that you're not going to get audited. The other thing is that the credit is sort of diluted on your return if you have a flow through entity. So a flow through entity would be your S corp or llc or if you're a sole proprietor, you're not a C corp and that entity is not paying the tax and that's not where the credit is levied. This credit will flow out to a personal return and kind of get masked. So it's hard for the IRS to audit and find out where that credit was applied.

Okay, so most dentists are S corporations. Very, very few are C corporations. And for you listeners, C corporations are generally larger companies, companies that issue stock options. All the big names you hear of, they're all C corporations. S corporations are really for smaller businesses and partnerships. If you have more than one owner, you're probably going to be structured as a partnership as opposed to an S corporation. And for some dentists who are maybe a little bit older or just have a smaller practice, they might be a sole proprietorship, which is just a income and expenses reported directly on the 1040 personal return rather than a separate tax return. For the S corporation, that's the 1120s. That's the most common. We file a lot of these things. So Andre, you're saying that the R and D tax credit isn't reported anywhere on the 1120s? Is that accurate?

It's reported there, but the credit actually flows out on your schedule K1. So the ultimate benefit gets onto your personal tax return, your 1040. So you, you report the credit there. But the 1120s is not a, it's not a tax paying entity. Right. So there's no taxes being assessed there. It all flows out to your members returns.

Got it. Do you know, can a sole proprietor even qualify for an R and D tax credit? You probably don't deal with sole proprietors at all in your sphere of businesses.

They can, right? They can't. I mean oftentimes you can't limit it to one type of entity type. It's hard for the IRS to do that. So yeah, you can be a sole proprietor. You wouldn't be denied a benefit just because of your entity structure. Right. You could still claim a credit. But like I said, oftentimes this credit is kind of massed and small compared to the other things the IRS is looking at. So I get the sense that there's just not a lot of activity at this level. So they're kind of getting away with very aggressive claims without getting looked at.

And we know that the IRS is understaffed and has been for a long time. And so it is true that the irs, if they're using their resources intelligently, they are going to go for the whales, they're not going to go for the little trouts out there, they're just not going to.

It seems to be the case. You wouldn't get a false sense of security and say like, oh, you claim this credit because you're not going to get looked at. Right. That's not the right way to look at it. Right. So. So I think a lot of people get duped into thinking that their credit is good or they're getting promised that we won't charge you if you don't get a credit. So that sounds like, oh, it's a great deal. I'm not going to pay anything if I don't get a benefit. Right. So yeah, the IRS is going to have to find out a way to enforce this at the lower levels. You know, we don't want people to forego a credit if they deserve it, but we also don't want to see a rampant abuse and sort of sometimes that's what we see.

Well, I could see why businesses get into doing the R and D tax credit consulting to smaller companies because they essentially do go through under the radar. I mean, I've had a lot of clients on their own decision do the R and D tax credit. I have to just state it for the record. I Haven't had any of those audited and overturned by the IRS. And they're getting $75,000, $150,000, $300,000, depending on the size of the practice and how much spend that they had in this research and development area of their, of their business. And so it is, from a practical standpoint, sometimes it's hard to have that conversation and even debate it. But I think a lot of these R and D consulting companies are. Their business model is essentially banking on this fact that these are not going to be looked at. If they do a 200,000 R&D tax credit, they charge 20%, they get 40 grand. They, they probably have a template report for a dental office, a template report for this type of business and this type of business. And they basically just need to get the sale to say, yes, I'll have you do my R and D tax credit. They fill in the blanks and then they send it off and get their 40 grand. Now, I'm sure there's more to it, and I don't want to state that. They're literally just filling in some blanks. I'm sure they go into the office or I'm sure they do some level of analysis. There's. But I think in its essence, that's probably what's happening. And a lot of people are making money off of this through the tax code. This leads to my next question, which is this could get complicated. So keep it as simple as you can, but how is the R and D tax credit calculated?

The R and D credit on the actual tax form is called the credit for Increasing Research Activities. It's kind of a mouthful, but what effectively that says and does to the mechanics of the calculation is that you drive your credit based on three main types of expenses. Those are wages of internal employees, supplies that are used and consumed, and then any contractors you may have paid to perform R and D on your behalf. And once you've established those net expenses that are eligible, we call those qualified research expenses or GREs. You evaluate those GREs over what they call a base amount without getting too much into the weeds. The base amount acts as a hurdle. So if you are increasing your RD spend over time, you effectively get a benefit. If you're decreasing your RD spend over time, you kind of get a detriment. So that's why it's called the Increasing Research Activities Credit.

Okay, so they're basically saying up to this hurdle amount, this base amount, you're not going to get a credit because you may just be dabbling it's just a little bit. You're not serious about it. But once you hit this baseline, you're showing a commitment to an innovative process, true research and development process. And so it's anything above that. So am I accurate when I say that they're getting to deduct these expenses on their P and L, their profit and loss statement, as supplies, as wages, as independent contractor, as if they were never doing the research and development tax credit and then they get to quantify those above that base and then file a credit and a credit. How much is that credit? I can't imagine it's dollar for dollar. But they get some portion of that back in addition to getting the deduction the first time around when they made the spend. Is that accurate?

Yeah. Let me separate these concepts. So one is the types of expenses I mentioned, wages, supplies and contractors. You are an aff deduction that reduces your tax liability as you normally would deduct expenses. And those same expenses are used to generate a tax credit which is a dollar for dollar offset. There's a limit to how much credit you can use which is effectively limited to 75% of your tax liability. So there is some sort of limit there, but it is dollar for dollar. You have to reduce your expenses in the amount of the credit claimed. So you can't double dip. But that's another like nuance. We don't have to get too much in the weeds, but effectively you get a both deduction and a tax credit on the same expenses. Now this is an important thing to mention right now with the Tax Cuts and jobs act of 2017, there was a provision in that enactment that said starting in 2022, you must capitalize and amortize your R and D spend over a five year period if they're domestic or a 15 year period if they are foreign. This was meant to help offset the revenue that would be lost by lowering the corporate tax rate. And in effect they give a five year because it started in 2017. They give a five year start date to prolong when you have to capitalize these expenses. But the idea was that they would have some kind of fix before that would ever take place. So what they're saying here now is that of course a fix never happened. There was a build back better act which failed, that had a fix in there so you can continue to immediately expense your R and D expenditures. But that never happened. So as of now, the current lay of the land is that starting in 2022, you must capitalize and amortize those costs. So you lose a lot of those deductions, at least temporarily.

Okay, so in a scenario where I'm a dentist and let's say I am, this is honestly where I struggle trying to think of a scenario where it may apply. And let's say I'm trying to develop a new bonding material. Yeah, this is very unusual. Most of my clients are not spending their days trying to develop a new bonding material. They're buying their bonding material from their supplier. But let's say they're trying to, they have their little lab area and they're trying to create a new bonding material and they spend $200,000 on this in supplies, in some wages, maybe some independent contractors to come in and do some consulting. $200,000 over, let's say a year long period. Normally what they're probably doing is they're probably just deducting those costs on their P and L, like their normal supplies and labs and other expenses. So that's $200,000 that they deduct on their provident loss statement. Now they apply for the research and development tax credit. There's $200,000 of this previously deducted set of costs that they are going to attempt to get back. Since it's $. Let's say that baseline is 100,000. I don't know what it would be, but let's say it's 100,000. So then they're going to try to get back $100,000, which is the 200,000 total less their baseline of 100,000. And it's a dollar for dollar credit. So they're trying to get back that $100,000. So they got, let's say they were in the California 50% combined federal state tax bracket on that 200,000. They already got $100,000 tax benefit at the 50% tax rate on that original normal deduction. So they got $100,000 there from the first set of deductions. And then they're trying to get $100,000 back from the credit, essentially fully offsetting that $200,000 spent. If anyone didn't follow that, maybe just rewind a little bit. Go through the numbers with me. But Andre, you're following me there. So the two questions are to confirm they do get to deduct that first hundred thousand as a normal deduction. The second question is if the credit is if it's allowed, if they file for it, is that right, that they get the 100,000, but you're saying that now they don't get the 100,000. Right away they get the 100,000 credit over a five year period.

The second part correct. Right. So right now the lay of the land is starting in 2022, you must capitalize those costs. So let's put it more simply than to try to get too much in the weeds and do the math. If you were approached right now and you were never doing R and D credit facility before, your net benefit would be detrimental to your practice. So if you were to claim an R and D credit and by virtue of this capitalization of your R and D costs, because you're basically saying these are R and D costs, I have to capitalize them, I will take a credit, but I will have to defer my expenses over a five year period. In year one, you will be a net loss from doing the deal. That's not to say you won't recoup those costs over time, but for cash flow purposes, you will be out of pocket. A lot of people don't understand that concept. It's really tax technical. We have to probably show you an Excel spreadsheet to show you how the math works. But I mean, that's something that these practitioners or these practitioners, these aggressive promoters are not going to articulate this to your clients.

Okay? So when I spend that $200,000, normally I would be deducting that on my profit and loss statement. It flows through on my 1120s tax return as expenses. Just like my labs and my normal supplies, yada yada, all that stuff, it's all deducted. But now because of that 2017 tax law change, I actually don't get to deduct that in year one.

Yeah, a five year period. And in year one there's a midpoint convention. So let's just call it, you get 10% of what you normally would have been able to deduct. So typically you would have deducted the entire 200,000. Under this new section 174 capitalization issue, you would get 10% of that in year one and then 20% in the following years. Until the last year you get another 10%.

Is there an election to forego that five year deduction and get the full deduction in year one?

There's no election. Right. It's mandatory. But basically, if you are not calling your expenses experimental in the section 174 definition of research and experimentation, then those are ordinary and necessary business costs you get to deduct. So if you're not calling them R and D, then you're fine.

Okay? And that's an important distinction, because if you're saying that $200,000 was actually just in the ordinary course of my business, I'm making stuff, materials that I'm actually using with my patients, that kind of thing. What the IRS generally will say is if you are trying to create something new that may, that isn't directly attached to revenue, you have to capitalize that. That's just a general rule. So if you're developing a software, for example, and let's say you're a dentist and you're trying to code your own new practice management system, actually, I have a client who did that, then that cost for the coding for your development team is really not deductible against your normal dental revenue. You have to capitalize that. And then you would deduct it when you have revenue coming in from that software that you would develop now with that 200,000. You know what this reminds me of, Andre? It reminds me of depreciation. And this is an important concept I think most dentists should, all dentists, business owners should understand is that when you go and you buy, let's say you buy a cone beam, you buy this X ray machine, and I'm going to use a flat $100,000. You buy it new, it's $100,000. And I'm going to say for a sec that you bought that in cash. Generally that's not the case. But let's say you bought that $100,000, you wrote a check, it came out of your checking account to buy that cone beam X ray machine. And with the irs, their normal standard rule is, is when you buy equipment, it's not like supply that you're using day to day. You're going to get a benefit of that equipment over time. And therefore we're going to have this thing called the matching principle, where you're going to deduct that $100,000, meaning get the tax benefit of paying that $100,000 over the useful life of that equipment. And they give you these standard time periods, and in that case it's going to be five years. And so you would deduct that $100,000 over five years. If it were sort of straight line, it would be 20,000 per year. Now, in reality, it's not straight line. They have a formula called makers depreciation, where you might deduct, like in your example, Andre, 10% in the first year, 25% in the second year, 20% in the third year, and then it sort of tapers off near the end but there's this election where you take call the Section 179 deduction. Now, most of my clients who've owned their business for a little while are going to be familiar with that term because their rep from Henry Schein or Patterson or Burkhardt or wherever their dental supplier is will generally come in near the end of the year and say, if you buy this equipment, you buy this dental chair, you buy this laser, you buy this CAD cam, whatever it is, you buy this and you claim this 179 deduction, you get to write 100% of that off. You don't have to wait the five years, so you get $100,000 tax deduction. There were similarities in the way the IRS is allowing this R and D deductions, these R and D expenses to be the benefits received over time. Same thing when you buy that X ray machine. The benefit is received over time from a tax standpoint, but with the equipment, you can move all that depreciation, move all that deduction forward in the current year through this section 179 deduction. The problem with a lot of dentists, the trouble they get themselves into is they take out a loan for that 100% and sometimes there's a 6 to 12 month period where they don't even make a payment and yet they get the $100,000 deduction. And if they're in that California federal state, 50% tax bracket, they just save $50,000. They didn't come out of pocket a dollar and they got an X ray machine. And their CPA looks like an absolute all star. And they're just like worshiping their cpa. But then the next year they, they have a lot of money that starts to go out on the payment for this and they essentially get no tax deduction other than a little bit for the interest portion on those payments. And then they get into this tax trap where they have to buy another one at the end of the year just to get them out of the hole that they created from that first year. So one of the themes in our financial consulting meetings that we do at Dent is we usually meet three to four times during the year as their outsourced CFO is we take a long hard look at what equipment have you bought, what they're called, fixed assets have you bought in your practice and how are we going to properly treat the depreciation to make sure that you don't fall into a trap. And my rule is generally if you pay for it in cash, then or whatever extent you pay for it in cash, let's depreciate that portion in the year to match the cash outflow with the tax benefit. And that sort of keeps us safe on it. On occasion we'll make exceptions to that. We just have to plan for taxes going up when they don't have the same depreciation in the following year. Now that was a little bit of a tangent going into the education of buying equipment, which is a highly relevant topic for dentists because they're a capital intensive or equipment intensive type of business. Let me ask you, coming back to the R and D tax credit, these aggressive salesmen, are they on the hook at all? If an audit were to occur and it be revoked, what risk do they have?

Well, depending on their contractual relationship or whatever they set up with the practitioner, they can throw their hands up and say, well, you know, the IRS has taken this position and we don't agree with them, but we can't fight it or it's too expensive to fight. I mean, that's what it kind of comes down to is that if you're claiming a credit that's relatively small, the next step would be that, okay, well, I'm going to fight this and I'm going to have to answer. A lot of what they call IDRs is what IRS will issue. And those are, those are document requests that the IRS will send to you and kind of ask you to produce a lot of documentation to describe why the costs met the requirements outlined in the four part test. And so the person who sold you the tax credit could say, well, if you don't have the documentation, then you're not eligible to sustain this credit and they'll kind of throw their hands up. So there's not a lot of recourse on their end. I think that they kind of know.

That, you know, it's interesting that 2017 tax law change that caused or forced the capitalization of those expenses. So you don't get to deduct those, in my example, that 200,000 in that year, you only get to deduct say 20 or $40,000 of it and you're actually at a loss that year. You said that kicked in five years after that day.

Well, yeah, the 2017 tax cuts and Jobs act, the major intent there was to lower the corporate tax rate. And they use these revenue offsetting measures to help balance the budget of that act. And this was one of the major ones, was to say, okay, we're going to lower the corporate tax rate and help pay for that loss of revenue in Five years time, we'll, we'll make everybody capitalize their R and D spend. And so that's okay. But the reason they give it a five year start time was that they were like, hey, wink, wink, we'll have this fixed before that ever takes place. And they didn't get it done. So that's kind of where we're at.

Very sneaky though, very political to do that. They're like, this is how we're going to balance out our tax cuts. But we know that we're not actually going to implement this offsetting feature that would raise taxes. But it actually happened though. They never did. The build back, better plan never rolled out. So they never, they were never able to implement that. So then in 2022, five years later through today. So for the past roughly two years or so, any R and D spend is having to be capitalized and not deducted then, is that right?

That's right. But as they signaled before, there was several attempts to make this fix and in fact there's one that has already passed the House and installed in the Senate and that's called the Tax Relief for American Families and Workers Act. It's kind of a mouthful, but it has the, effectively the fix in that proposed piece of legislation. But we don't think there's going to be any action on that legislation until after the elections in November.

I haven't received a lot of inquiries about the R and D tax credit as of late. And I'm wondering if it's because the R and D salespeople have sort of backed off, knowing that the benefit isn't as strong at the moment.

I think people are getting wise and they're asking their CPAs or their CPAs are probably telling their folks, hey, starting now. Or maybe they felt the burn in 2022 if they've been claiming a credit for a while. Suddenly in 2022 the CPA says, hey, all these R and D costs you're claiming have to be capitalized. And then that gets back to the person paying the tax. You go, wait a minute, wait a minute. So I think maybe that has diminished them as a bit and that could be the reason why you're hearing less about it.

You know what though? All the R and D tax credits, the same people, all they did was pivot to the erc, the employee retention credit, which has been heavily abused. And the IRS actually about four or five months ago, put a moratorium or a stop on processing any new ERC claims because of the intense abuse that was taking place and unfortunately some of our clients who legitimately qualified for it under accurate calculations, theirs got stuck in the cog now and we have to wait for everything to sort of get, get moving again with the, with the erc. So those salespeople, they're going to find something to come at you with, that is for sure. And I will state for the record for anybody listening me and practice cfo, we are fairly aggressive on taxes, but we also do have a line that we draw. There's a line we draw and we as a firm have stated that the R and D tax credit is past that line. We just don't see scenarios unless there's an exception to a standard operating dental practice where the R and D credit criteria is actually met. But we have filed for a lot of ERCs for clients. Of course we filed the PPP for so many clients. We do home office deductions. We're pretty aggressive on running your car through the business. A lot of stuff that people call continuing education or mills and that kind of stuff. We're fairly aggressive on a lot of that. We do a lot of 401k and a lot of defined benefit plans for a really high cash flowing doctors that really chops off 50, 60% of their taxes with some of these defined benefit plans which are 100% legitimate if you manage them correctly. And tax planning, good tax planning isn't a single solution. It's a wide net that's cast across all of these areas that in the aggregate save a tremendous amount in taxes. The second part of tax planning is just making sure you're staying current on your various taxes. State, federal. In California there's a corporate franchise tax on S corporations. And now there's this new tax called the AB150 or the, or the pass through entity tax for flow throughs in states like California where they have a high state income tax. And the Trump tax code essentially eliminated that for that tax deduction for those states, which is if I'm paying 80 grand in California tax, I used to be able to deduct that on my schedule A against my federal income tax which was say 37%. And so now I got a, whatever, you know, I got a $15,000 tax deduction for paying my California taxes. Well that was, there are some details to it, but that was essentially eliminated with the Trump tax code there. And so what states did is they came up with this workaround where they said if you pay your personal income taxes through your corporation, if you're a business owner, you can then deduct it just like you deduct your supplies, and that's deducted federally. And so it's a workaround for that. And it added some complications. You got to file it a certain way. You got to indicate that when you make your payment a certain way. It made the tax planning a little more complicated. And I've had many new clients come to me, and their dentist didn't give them instructions to pay for that, and they were out of pocket more than our entire fee just because they didn't do the AB150 in California or their PTE in other states correctly. So good tax planning is done, as I always say, it's done in the full cash flow analysis and projection. That's how you can do really good tax planning. It isn't just the one trick, R and D tax credit or whatever that is. It's the aggregation of a lot of things. Well, this has been extremely educational content. Rich. Andre, I want to thank you for coming on the show, and I hope this clarifies the R and D tax question for so many of our clients.

Who have asked us about it. Well, thanks for having me, Wes. Happy to talk.

All right, until next time.

Take care.