R&D Case Study: Meeting the Elimination of Uncertainty Criteria

Let’s take a look a R&D case study that our company recently completed for a client. Company XYZ is a manufacturer of customized shipping crates and containers. They build shipping containers for products that range from fragile ceramic needles all the way to containers used for 17-story satellite towers. The four-year average of gross receipts for XYZ was just under $10 million.

When we first met with the executives of XYZ, they didn’t believe that their company was carrying out any type of R&D activities. As a matter of fact, the company’s president commented that they were not a high-tech, innovative, or blue-sky-research company. After a few days of interviewing engineers, production managers, and designers at XYZ, however, we determined that XYZ Corp. had been involved in about a dozen large projects and activities per year for the previous three years that initially qualified under the permitted purpose criteria described above.

After initial conversations about the various projects and activities we had discussed with XYZ personnel, we examined the types of uncertainties encountered by those engineers, managers and designers as they related to the projects and activities we had identified. Based on our interviews, we determined the uncertainties encountered during the development of these special-purpose shipping containers. Uncertainties such as:

• How much vibration would the container withstand before any damage would be done to the contents?
  
• How far (in inches) could these containers drop or inadvertently fall without damaging the contents?

These uncertainties are excellent examples of the sorts of things that satisfy the Elimination of Uncertainty criterion under US Treasury Regulations.

The third step was for us to interview personnel at XYZ who actually conducted the tests (vibration and drop) on the containers for the specific projects listed. We went through their notes and their documentation of the evaluation process of these tests. We were also able to meet with other XYZ employees who had intimate knowledge of these evaluations.

The final step that we needed to deal with for XYZ was: did the process rely upon the hard sciences? This criterion, as mentioned earlier, was fairly easy to overcome. It was clear that principles of engineering and physics were the major development components relied upon for construction of the custom creates.

Once all of the technical requirements of the R&D credit were satisfied, the next step was to look at XYZ’s financial information. Subsequent to meetings with XYZ financial personnel, as well as the executive management team, we were able to determine that there were qualifying wages in the amount of approximately $280,000. Additionally, we also discovered an additional $40,000 worth of material and supplies expense directly related to these projects, as well as approximately $30,000 of outside consulting as it related to the actual tests performed on the customized crates.

Once we completed the R&D study, XYZ had more than $115,000 in Federal R&D tax credits available. This was like found money! Amended returns were promptly filed and refund checks were received by the shareholders (XYZ is a Sub Chapter S Corporation) approximately 90 days later.

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