Don't miss out on overlooked tax credits
Are you missing out on R&D credits?
(FORTUNE Small Business) -- Lee Avery had never really thought of his company's work - producing parts for underwater oil and gas pipelines- as involving research and development: His engineers don't wear white lab coats, after all. So Avery, co-founder and president of Quality Connector Systems of Houston, was initially skeptical when he was told that his four-year-old company was eligible for tens of thousands of dollars in annual tax savings from the $7-billion-a-year U.S. Research and Development Tax Credit Program.
After filing for the credit, Avery, 60, received a check for more than $100,000, representing tax overpayments for the previous three years. Avery is not alone. Many small-business owners engaged in engineering, manufacturing, software, chemicals, defense, and other sectors that the government considers essential to American innovation are unaware that they could be eligible for valuable R&D tax credits.
"Almost every client I've run across was either not claiming the credit or claiming it incorrectly," says Shawn Marchant, a tax lawyer at Holthouse Carlin & Van Trigt, a Santa Monica accounting firm serving small and medium-sized businesses.
Avery had received guidance from the tax consultants at Houston's FortisTCS, which specializes in helping small and midsized companies get their share of tax credits that Fortune 500 companies routinely secure.
"The Big Four accounting firms have huge departments working on this for their billion-dollar clients. Companies such as Microsoft (MSFT, Fortune 500) get hundreds of millions back a year," says Santosh Varughese, 44, co-founder and CEO of Fortis. "Yet the government initiated this program to reward small companies when they take risks to innovate." In addition to Fortis, Axiom Solutions of Denver and Tax Projects Group of Cleveland offer similar services.
To encourage small companies to undertake the burdensome paperwork required to claim the credits, Fortis offers free feasibility studies and a contingent-fee structure, in which it is paid - typically around 30 percent of the savings - only if the client collects a check. If tax credits have been overlooked in past filings, companies have three years to file an amended claim with the IRS. For QCS, Fortis identified certain projects, such as a recent innovation involving a more efficient way to clean pipe connections, that were eligible for the credits.
"It seemed too good to be true," says Avery. In a process that took about six weeks, Fortis compiled the documents necessary to substantiate the claim and filed an amended return. (Though the demands on staff will vary, a business should figure on at least several weeks of one employee's time to gather all the information the accounting firm needs.) The $100,00 in the company's savings, however, more than made up for the extra cost, and Avery was able to plow the balance back into new-product development.
Fortis's Varughese knows firsthand how easy it is for busy business owners to overlook tax credits. In 2000 he was absorbed in running an optical-recognition software company that had grown to $8 million in annual revenue in three years. He hired as CFO a former KPMG accountant, who made an offhand remark that he was going to go after some tax credits. When three checks totaling $280,000 rolled in, Varughese called the CFO into his office and said, "What is this money, and how come I'm not aware of it?" He recalls: "A light bulb went off in my head. I started making phone calls to other companies, and eight out of 10 had never heard of the R&D tax credits."
Today, Fortis has assembled a team of 44 CPAs and 12 tax attorneys who work with a client's CFO or CPA to determine eligibility and then do the legwork.
One aspect that seems too good to be true - the contingent-fee structure - soon will be. In late September the IRS issued a rule that will severely restrict the ability of tax consultants to price with no upfront fee, except in a few specific situations, such as when a client is being audited. The new rule takes effect in March.
For the one-third of Fortis's clients that have been on contingency, the company plans to switch to fixed fees come March and to set charges based on the client's past contingency-fee payments. For new clients, the fixed fee will be based on an estimate of the potential tax credit.
One caveat: Companies subject to the alternative minimum tax cannot use the R&D tax credits, although they may be carried forward for 20 years. The AMT, however, may not last forever, and 20 years is a long time. 
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