BCP recently completed a presentation on the Research and Experimentation (R&E) Tax Credit and Deduction at the EEI Tax Committee meeting in New Orleans, Louisiana. The last discussion point was an example of how to get started with assessing the level of R&E potential investment your organization is making. In this issue of the R&E newsletter, we further that discussion by providing a step-by-step guide on assessing potential R&E investment.
Electric Utility organizations engage in significant levels of capital improvements, for which the list of capital projects can be exhaustingly lengthy and can present a daunting task to review for R&E activities. It’s not uncommon in a given year to see hundreds of new and ongoing capital projects per plant and/or business area.
Because of the staggering number of projects, it’s important to apply a good screening process to streamline the project list and identify the most likely R&E candidate projects – this will save you time, effort, money and most of all frustration over the long run. Below is a step-by-step process that is easy to implement and that I believe you will find helpful.
Step 1: Obtain from property accounting or similar source a capital Construction Work In Process (CWIP) project listing by year for each generation plant, transmission, distribution, and common projects (projects that may span across multiple plants). The project list should contain at a minimum:
- Project code
- Project title
- Project owner (plant, business unit, etc.)
- CWIP spend for the tax year in question (and prior 2 to 3 years)
- In service date
- Project description (often systems will contain a longer text description of the project).
Step 2: Prioritize the project list by dollar amount for the tax year in question – highest dollar amount to lowest dollar amount. Organize the list by plant or business unit whichever best fits your company’s organization.
Step 3: Develop a baseline cutoff. BCP typically cuts projects for a singular year at the $500k level and will perform detailed project investigations for those that appear to have $250 – $300k in potential tax deductions. Because of the level of substantiation being requested by the IRS; the cost of obtaining, documenting and supporting smaller project claims can be greater than the tax benefits realized. Obviously there are always exceptions to this rule, which I’ll address later in the article.
Step 4: Review the project list by title and description (if available) for key terms/words that indicate the project may have significant design engineering work. Key words include: upgrades, enhancements, tests, studies, uprates, life extensions, or other specialty projects that appear to be unique (this is a short list of project types and not intended to be an exhaustive list). Alternatively remove projects from the list that appear to be replacement oriented (like for like replacements) such as valve or piping replacements. The reality is that much of the language you will review will look a bit foreign, so it is always a good practice to sit with a knowledgeable, experienced engineer that can review the list and provide practical experience in assessing project potential.
Step 5: For the new list of projects developed in Step 4, look at the annual spend for the current tax year in relation to the prior 2 to 3 years. Remember you are looking at the list to identify R&E activity potential, so typically you’re looking for spending in the early stages of a project where most design activities occur. To assess ask yourself these questions for each project:
- Is this a new project in the current tax year? If yes, then there is potential for R&E activities.
- How far along is this project? Is it year 2 or 3 of a 5 to 6 year project? If so then there is potential for R&E activities.
- Is the spending in the current tax year magnitudes larger than prior years? If so, then keep this project on your list. It may turn out that the costs are material or installation related, but at this point you don’t know.
- Review the in-service date for the current tax year? Was the asset put into service for a given tax year or prior year? If so, not likely to have significant R&E activity.
Once you complete this exercise, you should be left with a significantly shorter, targeted project list that is manageable. This list should serve as the basis to begin conversations with project managers or engineers to understand if these projects contained significant levels of design engineering costs. For a quick “down and dirty” estimate multiply the project costs for the tax year by 10%, this will provide you a rough estimate of R&E Section 174 potential.
Now remember in Step 3, I mentioned there are exceptions to the $500k baseline rule. It often pays to review the less than $500k projects for tests, studies and/or experiments for which the bulk of the costs will likely qualify – while the total project dollar amounts are smaller the majority of the project costs are typically eligible for R&E. You can do this by using Excel’s key word search capabilities in the project titles and description columns of your project list.
The process steps described above provide a simple, high-level assessment of the R&E potential that exist in your organization. It is important to remember this is not a final assessment. Once you’ve identified the projects, there remains significant effort in identifying and analyzing the detailed project costs, vendor and internal staff involvement, understanding and substantiating the engineering uncertainties that had to be resolved on the project and performing the necessary detailed analyses to develop the detailed correlation between cost and activities.
About the Author:
Greg Lormand is Director, Tax Services for BCP Engineers & Consultants where he concentrates on supporting clients on niche’ tax areas such as Research & Experimentation. Mr. Lormand has a BS degree in Mechanical Engineering and Masters Business Administration from Louisiana State University.