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Private Equity 360: Research & Development (R&D) Tax Credits: Hidden Benefits

Bob Woosley, National Private Equity Leader discusses R&D tax credits with Tommy Zavieh, National R&D Tax Credit Practice Leader.

Topics include the history of R&D tax credits, the qualifications, benefits and why you need a R&D tax credit specialist.

Private Equity 360 is available on iTunesSpotify and Google Play Music. Listen now using the player below or download it to listen later.

R&D Credit Podcast Transcript

This transcript was assembled by hand and may contain some errors.

It has been edited for readability.

 

Bob: Hello everybody, this is Bob Woosley, National Private Equity Practice Leader at Frazier & Deeter, and we have a great subject today. There have been some changes in the Research & Development tax credit, and I’m here with one of our tax principals, Tommy Zavieh. Hey, Tommy. How’s it going?

Tommy: Great.

Bob: Tommy, we’re going to talk a little bit about how this affects our private equity clients and their portfolio companies, but first can you give the listeners a little bit about your background?

Tommy: Sure, my background is a little bit different from my colleagues. I started out as an engineer and then wanted to go to grad school, but found out that I wanted to do something a little bit different, so I got my MBA and my MS in tax. I think this area of R&D tax credit is the perfect marriage between my engineering background and my tax expertise. Career-wise, I’ve been in New York, California, Australia, I’m an expert in Asian tax regimes, European regimes and obviously the U.S.

Bob: So, most people who have been practicing business understand that there’s a credit out there called the Research & Development tax credit. Today we’re going to talk about some changes that have happened because the tax law is changing; the corporate rates are going down. Can you take a step back, why does this credit exist? What is the government trying to do?

Tommy: That’s an interesting question. It started out actually after WWII, to give you a little bit of history. We wanted to get back into competing with the world, so it started as a deduction that was put into the books to help companies spend money on Research & Development here in the U.S., and then it became a credit in 1981 underneath Reagan. Since then, companies have used this to basically put cash back into the company and spend more money on Research & Development, so it’s been around for quite some time.

Bob: Right, it’s about the United States wanting to innovate and continue to explore new products and services and that kind of thing, right?

Tommy: Exactly, and to do it here in the U.S.

Bob: Okay, great. You’ve spent your career in this, I know you’ve recovered tons of money for companies, but tell us a little bit about how the credit works. And then maybe we can get into some common misconceptions about the credit, so give us an overview.

Tommy: Sure. So, from a very high level, many industries qualify for the R&D credit. It’s not just your technology companies or large corporations or manufacturers that get the credit. Also, there is a federal and a state credit, so you can get a credit from both the federal and from the state perspective.

Bob: Wait, so I didn’t realize there were state credits. I always thought it was a federal credit. Like, you and I are sitting in the state of Georgia right now, so does Georgia have a state credit that marries with the federal credit?

Tommy: There are actually over 40 states that provide the R&D credit. Georgia happens to be one of the better ones. Not only is it a pretty good credit back from your Georgia tax liability, but companies can also choose to offset their payroll tax. Say a company doesn’t have a tax liability in Georgia. They’re going to think, why should I do an R&D study and get an R&D credit in the state of Georgia? Well, they can offset their payroll with that. That’s a pretty good chunk of change back in their pockets.

Bob: Do people normally miss that? Maybe we ought to talk about that because you and I have been talking about a service we offer to private equity firms looking across their portfolio with companies in all different industries and you just mentioned that the credit applies to different industries. I always thought it was manufacturing, and that’s where the main focus might be, but if you were going to look at what’s commonly missed across a portfolio of, say, 15, 20 companies, how would you bucket that up?

Tommy: I think the number one thing is education. The portfolio owners are unaware of what R&D is, or they have misconceptions regarding R&D. I have a definition of R&D, but that’s my bias of being an engineer. The way the tax rules work is that there’s a 4 part test; as long as you meet it, your activities qualify for it. So the number one need I would say is education from a portfolio perspective and from an entity perspective. Even the CFO or the controller may not know that they qualify for the R&D credit. So it’s really important to talk to a specialist to get an understanding of what activities they’re performing to qualify for an R&D credit. So that would be number one.

Bob: Well, not to interrupt, but you’re validating what I’ve already been feeling with my private equity clients, that they don’t understand how much credit they could be getting. So, you have this way of looking across a portfolio and diagnosing likely candidates. Can you talk about that a little bit?

Tommy: Yeah, just think if you go to your general doctor, practitioner. He’s going to be able to tell you a lot of things about you, but he’s not going to be able to very quickly tell you what’s wrong with your heart, so they’re going to send you to a cardiologist. But when you go see a cardiologist, you spend five minutes with that cardiologist, and they can diagnose you very quickly, why, because that’s their area of specialty. They know their subject matter. My colleagues out there know their subject matter. So talk to a specialist about this because a lot of times companies either completely miss that they qualify for R&D credit or they’re not maximizing their R&D credit. It’s super important that you come talk to one of us.

Bob: Right, you’ve told me horror stories where a company has tried to go for the credit and taken the credit, and you’ve reviewed their credit calculations and found significant areas where they didn’t capitalize on it, where they undershot it. Is that correct?

Tommy: Not only that they undershot it, the company was publicly traded and it had a significant impact on the earnings per share. So, the company was not only happy that we found the credit for them, but it gave them a boost on their earnings per share when they announced that they were getting this credit.

Bob: That’s a real value and for a private company, portfolio companies, or private equity firms, that’s all they’re trying to do is create value. So, you have a way of uncovering EBITDA that they’re not seeing and therefore value, and obviously cash and capital.

Tommy: And for your private equity clients who are considering potentially buying a company, this brings value to that company who’s not taking that R&D credit. Maybe they have not known about it or the credit they took may have been undervalued, so we can come in and help them value the R&D part of it to see if cash could be had here.

Bob: I really like the service that you offer, and it’s a free offering to go into a private equity portfolio and do that high level diagnostic of likelihood. You know, these companies probably would qualify if you took a look at it and you can get there real quickly. I think that’s a tremendous value.

So, moving to a different topic, what you do is highly specialized, and I know there’s a lot of CPA firms that just don’t have that kind of expertise. I mean, the average tax CPA firm can’t really do this unless they’re all in. Is that how you would characterize it?

Tommy: Yeah, I mean the way I would state it is, again, take the analogy of a doctor. Your general practitioner is going to be fantastic at being a general practitioner, but this is a very specialty area. It used to be an area that the IRS called a Tier 1, so they really came in a looked at it in detail as to what you were doing, so even the general practitioner was putting a number on your return, that number could be at risk potentially if they’re not doing it correctly and if they’re not substantiating it correctly. Absolutely, this is an area that you want to talk to a specialist to maximize your benefits.

Bob: Okay, so let’s move over to the fact that the tax law has changed. We have lower corporate tax rates. You were in my office the other day talking about how the Research & Development tax credits also had to change to mirror that. Can you talk a little bit about that, because you were actually excited about some of the changes that would benefit a company with the credit.

Tommy: Yeah, I equate this to winning a World Series or Super Bowl championship. The R&D credit has not had many wins from a congressional perspective. It’s been in the books since 1981 but it has not been a permanent part of the tax code. When the PATH act was passed by the president in 2015, it made the R&D credit permanent. When the Tax Cuts and Jobs Act lowered the corporate rate from 35% to 21%, that provided a boost of over 21% net benefit to companies working to get an R&D credit. So you would say, okay, it’s a 14% tax rate cut, how does that equate to 21%? Well, if you do the math, it actually is 21.54%, we’re not going to go into the details on this podcast, but believe me it is more than 21% benefit cash back in your pocket. So this is, for us in the R&D tax credit world, this is like winning the Super Bowl or winning the World Series when you’ve been on the sidelines for over 35 years.

Bob: So, it’s super important right now to look at these credit situations, whether you’re a private equity firm or just a regular company because things have changed for the better. So Tommy, as we wrap up, we talked about a lot today and I really appreciate your expertise. Are there any other thoughts we didn’t cover you’d like to point out before we close up?

Tommy: To our listeners out there, what I would tell you is just pick up the phone and give us a call, let us learn about your business, let us learn about your activities, and let’s see if we can help you out. Don’t go at it alone, especially since there is no charge for an initial assessment. This is not something that I would recommend you trying it by yourself or pursuing with your general accountant. Hire a specialist for this area.

Bob: Yeah, and I need to say that you can reach us at www.frazierdeeter.com.

Tommy: To reach me, you can email me at tommy.zavieh@frazierdeeter.com, or you can call me directly at 404.573.4514.

Bob: Great. Well, thanks again for your time; it’s been great talking to you today.

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