R&D tax credits available to agencies with Mike D’Alessandro

Speaker 1:

If you’re going to take the risk of running an agency, shouldn’t you get the benefits, too? Welcome to Agency Management Institute’s Build a Better Agency Podcast, presented by White Label IQ. Tune in every week for insights on how small to midsize agencies are surviving and thriving in today’s market. We’ll show you how to make more money and keep more of what you make. We want to help you build an agency that is sustainable, scalable, and if you want down the road, sellable. With 25 plus years of experience, as both an agency owner and agency consultant, please welcome your host, Drew McLellan.

Drew McLellan:

Hey, everybody, Drew McLellan here, and guess what? I am bringing you another episode of Build a Better Agency. I know, I suspect that doesn’t surprise you at all. I am always grateful to be here and always glad to spend some time with you. I think this episode is going to absolutely capture your attention. And, I am betting that many, many, many of you are googling things while I’m talking to the guest to see how you could take advantage of what we’re going to talk about. So, I’m anxious to get to that conversation, but first I want to tell you a little bit about a workshop that we have coming up. And the reason why I’m telling you about this workshop is because it’s money-related, and this episode is all about the money.

And so, on December 9th and 10th, we will be in Orlando, Florida, teaching the Money Matters Workshop for two days. All we do is talk about money. We talk about agency math. We talk about the metrics that tell you things like, “Am I overstaffed? Are my people productive enough? Am I utilizing my team properly? Do I have too many non-billable people,” all kinds of things like that, that are actually metrics-driven realities. There’s nothing subjective about them, but for many agency owners, if you don’t know this math and you don’t know all of those metrics, you kind of operate the agency by the seat of your pants. I know I certainly did, many, many years ago before I learned this. And, learning all of these things, the agency math, the tax strategies, the pricing strategies, all of it completely changed the way I ran my agency. And so when we were building out this workshop, I was very mindful of the things that I didn’t know, and that really changed the trajectory of my agency once I did know.

So for two days, all we do is talk about money. How to make more money, how to keep more of the money you make. And so, again, that’s December 9th and 10th in Orlando, Florida. Would love to have you join us, and it’s completely and beautifully connected to today’s topic. So let me tell you a little bit about my guest and what we’re going to talk about. So, Mike D’Alessandro owns a company called Research Tax Credits, and there’s this thing in the US but actually, there’s also in many other countries like Ireland and Canada and other places. So, if you are not an American, do not despair and don’t leave. Don’t change the dial as they used to say. Stay with us because odds are, there is something in your country that is very similar, but for those of you that are based in the US, don’t move a muscle because you want to hear this.

So the federal government and 36 of 50 states have something called either a Research and Development Credit, or a Research and Experimentation Credit. And many agencies believe, erroneously by the way, and many CPAs believe erroneously that agencies are not eligible for these tax credits, but I’m telling you that many AMI agencies take full advantage of these tax credits and get 40, 50, 70, a hundred thousand dollars of tax credits, both federal and state every year. And they do it by filing some paperwork. That’s really it. So, my guest is going to tell you all about the history of this and how you go about doing this, and why every one of you should be exploring and investigating whether or not your agency is eligible for these tax credits. This is free money, and I want to get right into it. And I want you to hear all about it because I think by the end of the episode, you are going to be dancing a jig. That’s my prediction, dancing a jig. So let’s get to it. Let me introduce Mike to you, and let’s start talking.

Mike, welcome to the podcast. Thanks for joining us.

Mike D’Alessandro:

Hey, thanks for the invite, Drew. I really appreciate it.

Drew McLellan:

So, give everybody a little bit, a sense of your background, your expertise, and then obviously we’re going to jump right into the whole R&D credit discussion.

Mike D’Alessandro:

Yeah, so I have a Master’s degree in finance and I actually have an undergraduate degree in clothing, textiles, and interior design from Kansas State University.

Drew McLellan:

Comes in handy. I’m sure.

Mike D’Alessandro:

Yeah, it does. I’ve been involved for probably two decades in the construction field. So my first job out of college was working for a heavy highway contractor. And, I really, I have an understanding of how to build things, how to construct things. I understand finance and accounting, computer science, and throughout the process, things have evolved into data analytics, search engine optimization, search engine marketing, in addition to manufacturing, and construction, and food sciences, and agricultural sciences. So a really diverse background, on the hard science side and on the finance and accounting side.

Drew McLellan:

So, but you have a depth of expertise, you’ve really sort of specialized in this whole R&D credit thing, correct?

Mike D’Alessandro:

Yeah. I’ve been doing it for 14 years. Seven years for three national providers and seven years at Research Tax Credits.

Drew McLellan:

Okay. So let’s talk about when we say R&D credits, what does that mean? And then we’re going to talk about how it’s relevant to the listeners and agency owners.

Mike D’Alessandro:

Yeah. Well, most folks, they say, “Well, we don’t do any of that, because-”

Drew McLellan:

Well, first, what is it?

Mike D’Alessandro:

Research. When you say Research Tax Credit, and most owners, even we’ve got a lot of digital marketing agency clients and they say, “Well, we don’t do any of that stuff. We don’t. We’re not developing a product.” You don’t have to be developing a product, an application, software as a service, a tool that someone would pay to use. And you really have to be providing work on a fixed fee basis, or where there is a hard cap where the scope is clearly defined, and you were at risk for cost overruns. And a lot of our digital marketing agency clients, that when you explain the definition of research, are you trying to get better, cheaper, faster, more efficient, higher yield, less waste? Are you designing policies, procedures, protocols, best practices? People say, “Well, we do that every day. If we didn’t do that in a year, we would be out of business.”

Drew McLellan:

Right. So let’s go back, though. What is the R&D credit? Where did it come from? What does it mean? What do I get? And then we’ll get to why agencies can use it.

Mike D’Alessandro:

So the research credit was really, I mean, if you go all the way back, it was created in 1981. And Congress was really intelligent back then, because they said, “How are we going to control the global economy?” And the answer to that is control patents. And how do you control patents? You offer this thing called the research credit. So they created the research credit. And then in the middle two thousands, it became part of the Jobs Creation Act. And then it was further expanded in ’18, further expanded again. And the PATH Act, which was Protecting Americans From Tax Hikes Act, that was signed in December of ’15 by President Obama, was what really opened up three, four, $5 billion a year to small businesses.

Drew McLellan:

And these are tax credits, which means if I owe $50,000 in taxes and I have a hundred thousand dollar of tax credit, that wipes out my tax bill?

Mike D’Alessandro:

That’s correct.

Drew McLellan:

Yeah.

Mike D’Alessandro:

Dollar-for-dollar federal tax credits. And without … The federal law is the Research & Experimentation Tax Credit, or it’s commonly called R&D. There are also 36 states that offer … And now, the states call it Research & Development Tax Credit.

Drew McLellan:

Of course, nobody can get on the same page, right?

Mike D’Alessandro:

So, federal R&D … Yeah. State R&D, it is across the board. Everybody says R&D Tax Credit. Research & Development, Research & Experimentation. But, these credits are really, they are designed to stimulate business, to stimulate the economy. And since the PATH Act, really to create competitive advantages for small business owners, that create 80% of all new jobs in this country. So, it’s really something that Congress wants us to have, that the IRS wants us to have, because Congress has enacted this.

Drew McLellan:

Okay. So, you’re right. When you say research and development or research and experimentation, I’m sure a lot of agencies go, ” Well, I don’t have scientists on my staff. I don’t do research. I don’t. I’m not making new things,” but the reality is, correct me if I’m wrong. But the reality is for a lot of agencies, it’s the experimentation. The, “I’m trying something. I’m tweaking it. I’m optimizing. I’m trying to make it better.” There is no guarantee in the results that allows for agencies to qualify for this tax credit. Is that accurate?

Mike D’Alessandro:

Drew, that’s exactly right. Think of it like this. You’re rewarded for gaining new information, new knowledge, and trying new things that are new to you. Now, these are the new rules that are written into the spirit and the intent of the credit. So if it’s new to you, and you’re exactly right, if you’re trying different things, if you’re creating processes, if you’re trying to get better at what you’re doing. We have one tech-based client. They built out this thing called the Humdrum Library. It’s a library of all the best practices, policies, procedures, protocols, how to attack a problem. So, and they constantly update this library. And, every year when we help them with their credit, there might be 40 plus documents that have been edited in 2021. That all counts as improving your process. There might be newly created documents that count as new. Completely new processes that have been developed. So all of this activity counts. Researching new things, learning about new things. It’s rewarding things that are new to you.

Drew McLellan:

And this is in essence, if I understand it correctly, this is, I think what you called, it was a wage-driven credit. So what an agency does is they document how much of their people’s time is spent on these sort of activities, and then a dollar amount is assigned to that time. And that’s how the credit is established. Is that right?

Mike D’Alessandro:

That’s correct. So this is a wage-driven credit, and then, we have clients that do two separate things. There could be a wage. The wage-driven credit can be an activities-based approach or a project-based approach. So what you do, and let me take a step back here. And, the United States tax code, the base code is 74,000 pages, right?

Drew McLellan:

Light reading.

Mike D’Alessandro:

Right. If you ever can’t … The cure for insomnia is to go to the IRS’ website and read some of this.

Drew McLellan:

Yeah, right.

Mike D’Alessandro:

If you can’t sleep, if you don’t fall asleep after four pages of reading, you’ve got serious problems. But, the 74,000 base pages of the tax code, no one could possibly know it all. CPAs can’t know at all. When we give guidance, direction, and assistance to probably about four dozen CPA firms around the country, and they outsource the work to us because they can’t possibly know at all. They also don’t … You have to fuse tax engineering, accounting, and legal all into one. It’s very rare that a smaller, even the mid-sized CPA firm will have this expertise. So it’s a wage driven credit. There’s a lot of complexity, what’s you’re required to do. And it blows people’s minds that the same dollar that you take as an expense is a dollar that you can take as a credit. 54,000 base pages of the US tax code. There’s two pages you can do this in. If you invest in solar technologies and the research credit. So, it’s a legal double-dip. The same expense dollars in expense. The same expense dollar is also a credit dollar. So this is what makes this so lucrative.

And yes, it’s a wage-driven credit. So what we’re permitted to do is based on people’s job duties, job details, job description, project work, project involvement, administrative oversight, support, supervision, technical support, management support. We’re allowed to make reasonable estimates of someone’s time and how much they participate in these projects. And, we can base it on a time sheet, which would be a project-based approach or an activities-based approach on what this person does, day in and day out. And both methodologies are correct, both methodologies are acceptable. So we’re permitted to make reasonable allocations of someone’s time, and take the same expense dollar as an expense and take it as a credit. And, it could be anywhere between seven to 10% at the federal level. It could be anywhere from three to 10% on a state level.

Drew McLellan:

Seven to 10% or three to 7% of what?

Mike D’Alessandro:

Of the expense dollar.

Drew McLellan:

Okay. Okay.

Mike D’Alessandro:

Okay? So it can be significant. And you have to remember, this becomes a permanent part of your tax planning strategy. This is something you do every year. It’s not a once-and-done thing. It’s done every year. And it’s, again, it’s a permanent part of your tax planning strategy to really minimize the amount of tax liability that you’re paying. I say it all the time, there’s two tax codes in this country. There’s a tax code that’s written for the uninformed and there’s a tax code written for the informed. And we work with the informed. It’s just how it is. Unfortunately, there is a lot of complexity.

Drew McLellan:

So, we keep talking about digital agencies, but for a traditional agency that, I mean, everybody does digital stuff these days. Does this extend beyond things that are done online? I’m assuming it does.

Mike D’Alessandro:

Here’s the catch with the credit. It has to be in the hard sciences. So biology, chemistry, physics, if you’re in architecture, computer science. So where our marketing agencies fall under this, sales and marketing activities is specifically excluded from the credit. I want to make that perfectly clear. But what is included with our digital marketing agencies are data, analytics, search engine reports.

Drew McLellan:

Which every agency does, right? Yeah. Yeah.

Mike D’Alessandro:

Search engine optimization.

Drew McLellan:

Digital advertising, right? Or no?

Mike D’Alessandro:

What works, what doesn’t work? What are the keywords? Look, we have one client that has grown in five years to north of a hundred million dollars in sales. And they meet with Google in New York City with their data and analytics folks for two hours a week, every week, because they want to find out what they’re doing, how they, how are you getting a million people to your website a day? How are you getting them to spend two to $5 million a week, right? It’s all done by search engine optimization, search engine marketing, data and analytics, keyword, getting the people to the website, which is great, but getting them to find the things that they need, which is even better. And, the icing on the cake is getting them to pull out their digital wallet, order it, pay for it, and generate revenue.

Drew McLellan:

Yeah, yeah. Yeah. So really there’s probably not an agency in the US that’s not doing some of this. I mean, it’s pretty hard for an agency to have no online or digital activity for their clients.

Mike D’Alessandro:

That’s correct.

Drew McLellan:

Yeah. So, let’s say I get a credit. I’m just making up a number of $50,000 and I have a great tax accountant and I don’t know, $50,000. Am I SOL, or does that stay on my books? And …

Mike D’Alessandro:

That’s a great question. The federal credit carries forward for 20 years.

Drew McLellan:

Holy buckets.

Mike D’Alessandro:

Yeah, most of the states will carry forward anywhere between seven to 15 years.

Drew McLellan:

Wow. Okay. Why, other than ignorance, that they don’t know that this is out there, why would anyone not do this?

Mike D’Alessandro:

Well, and look, everybody always says, what’s your biggest competitor? The fact that people don’t know about it. And I’ll give you an RSM McGladrey statistic. RSM McGladrey, one of the 10 largest accounting firms in North America. They wrote an article, 41% of all manufacturers don’t know about the credit. And look, we’re headquartered in Pennsylvania. Pennsylvania has the largest rural population of any state, almost 10 million people live out in rural Pennsylvania. When you go into some of these rural small towns, it’s a heck of a lot more than 41%, what RSM McGladrey is estimating. I mean, you would think of a manufacturer should know about this, but four out of 10, I can tell you, it’s probably more like six or seven out of 10. Don’t know about it.

And the other thing too is we educate a lot of certified public accountants. Well, we do a lot of continuing professional education. We do a web based, we do live seminars, back when we used to do live seminars.

Drew McLellan:

Right, right. We’re getting back to that.

Mike D’Alessandro:

We’re getting back to it, but it’s amazing. I could be at one of the Penn State University satellite campuses, and there could be 50 to a hundred CPAs there. And, we talk for 45 minutes about the credit. And then I, at the end of it, it’s usually five to 10 minutes for open question. And I will ask a question back to the audience. Now I want to talk about, questions that you have when your client says to you, “Drew, you’ve been my CPA for 15 years. How come this is the first time we’ve been talking about this research credit thing?”

Drew McLellan:

Right.

Mike D’Alessandro:

I tell you what, if you want to silence a room, that’s the question to ask right? That’s it.

Drew McLellan:

Right. Yeah, that’d be very uncomfortable. Yeah.

Mike D’Alessandro:

Everybody’s pulling in all this knowledge for 45 minutes, and then they go like this. Heads are all, I mean, 50 to 150 heads do down. And I tell them, look, “Companies like research tax credits. It’s not like there are 15 of them in your phone book, or, in your Yelp.” I mean, our nearest competitor was Boston. And then they were bought by another competitor who was headquartered out of Fort Worth Texas. And my former employer is in Indianapolis and there’s another guy in Florida. And, so there’s not a whole lot of what I call specialty tax advisories out there. So the problem with the accounting firms is, who do I go to? Because I can’t find anyone local. Right? Who do you trust?

Drew McLellan:

If they even know about it.

Mike D’Alessandro:

Right. So, and I always tell people, “If you’re mad at your accountant for not bringing you this idea, I don’t know if we could do work for you.” And most people are like, “What do you mean?” Well, you have unreasonable expectations. You’re expecting your CPA to know all 74,000 base pages of the US tax code. If your CPA knew all 74,000 pages, they wouldn’t be your CPA, You wouldn’t be able to afford them. But, in all seriousness, there’s complexity to this. There’s CPAs, they have knowledge of it, but who do you refer? Right? Who do you have evaluate this for your clients? Who do you bring in? Who do you trust? The last thing a certified public accountant wants to do is lose that valued client, that valued client annuity, that valued relationship.

Drew McLellan:

Yeah, right. So, I want to, I’m assuming that this is complicated to file for this and all of that. So I want to take a quick break and I want to come back and talk about, now that everyone’s like, “Oh my gosh, I qualify for this. And it sits on my books for 10 to 20 years. I want some more of this.” So, I want to talk about process. I also want to talk about, can I go backwards and claim previous years? So let’s take a quick break and then maybe we’ll start with the, “Can I go back and get money that I’ve already spent taxes on?” And then we’ll talk about the process. All right, quick break, and we’ll be right back.

I’m really sorry to interrupt the show, because I know that you are into it, but I promise we’ll get right back to it. But I couldn’t miss this opportunity to tell you about a workshop that we’re teaching, the Build and Nurture Your Agency Sales Funnel. This is a workshop that I teach with Steven Wesner and it is sort of the next step after you read our book, Sell With Authority. And this is all about building a new business machine that works every day to attract right-fit clients, right to your front door. This workshop is a little different than some of our workshops. This is much more a hands-on workshop. There’s a lot of homework that you’re going to actually do in the workshop, because we want you to leave the two days with a completed marketing and sales plan. I’m talking tactics, I’m talking timetable, I’m talking, who’s going to do what at your agency? You are going to leave with it built out and ready to implement the very next week.

And we know that if we taught you how to do it, but we didn’t make you do it in the workshop, by the time you got back to the office and all the craziness that waits for you there, it would never get done. So that’s why we built this workshop this way. And it’s been very well received. And in fact, it’s back by popular demand. This workshop is January 20th and 21st in Orlando, Florida on beautiful Disney property. If you are ready to kick off the new year, being serious about BizDev and really sort of separating out prospects who aren’t that good for you, or aren’t going to be profitable, for the ones that are going to love you, stay with you and help you make money, come to the workshop, let us show you how. All right? Let’s get back to the show.

All right, we are back and we’re talking to R&D credits, and I suspect all of your heads are just exploding right now, as you are hearing what’s possible. And, that you are realizing that perhaps this is money you’ve left on the table. So Mike, let’s talk about, if somebody is hearing about this for the first time, can they go backwards? Can they retroactively apply for these credits? And if so, how far back?

Mike D’Alessandro:

Drew, another great question. Yes, they can. It is the current open tax year plus the three tax years that would follow the open tax year. So, right now, it’s 9/20. So, really, the corporate deadline was 9/15. So the open tax years right now are 2020, 2019, 2018. And the current tax year now really is going to be 2021 when it ends in another-

Drew McLellan:

Couple of months, right?

Mike D’Alessandro:

A hundred days.

Drew McLellan:

Right, yeah.

Mike D’Alessandro:

Within a hundred days of that date. So yes, you can go back. Going back would require amending the business return, and then the shareholder returns. For a lot of our clients that have one owner, it’s not a big issue. You’re talking about amending one return for the business that has a two page IRS form 6765, which is the form that is used to file the maintenance.

Drew McLellan:

Good old form 6765. I think we’re all very familiar with that. Yeah.

Mike D’Alessandro:

Yeah, no one’s ever heard of it until today. But, it’s a two-page form with eight numbers on it that flow the research credit either to the C Corp return, or if it’s a flow-through entity, the LLC, or sub-chapter S corporation, to the K-1. And depending on how you’re funding the business, the credit could have limitations or may not have limitations on whole income.

Drew McLellan:

Okay. So, I could end up with a huge tax credit from those previous years that I’m going to basically, well, so do I get to apply them then and get a refund or do I use that money? Do I get that credit for future taxes?

Mike D’Alessandro:

Both. So you could actually amend the tax return and get a refund check from the IRS plus interest, from the date in which you were eligible to file the credit.

Drew McLellan:

I have to tell you right now, I am envisioning thousands and thousands of agency owners wishing that they could crawl through their AirPods and kiss you and I on the cheek. I’m just telling you.

Mike D’Alessandro:

It is. And look, the IRS has grossly understaffed. They know, based on the principal business activity of the tax return that’s being filed, whether you should take the research credit or not. They understand that these digital marketing agencies have a data and analytics and computer science component. But they’re not going to tell you that, “Hey, you missed a really valuable credit.”

Drew McLellan:

Of course not. Right?

Mike D’Alessandro:

“We wanted to let you know, just to make our job that harder.” And, because the IRS is so understaffed, they’ve got benchmarks that they understand that, based on your wage, based on the number of computer science folks, based on the activities that you are conducting internally, and for others, that there’s a high range and a low range. And if you fall within that range, this is a very low risk proposition to apply for tax credits that could flow through as either refund checks with interest, or carry forward credits.

So, an example would be if you went back and amended ’18, ’19, and ’20, and you started in ’19 and you carried those credits into ’21 and ’22, and you have some really large clients that are generating incredible tax income the next two years. You carry those credits from ’18, ’19, and ’20 forward, you use them in ’21 and ’22 to minimize or eliminate your tax liability. If you’re a profitable older agency and you did pay tax in those years, you’re going to collect a refund check from ’18, from ’19, from ’20.the And four months from now, when W2’s come out, we’ll calculate the credits all over again for tax year 2021. And we have a lot of clients that they’ve got to make a quarterly tax payment on 1/15. So the end of December, they want to know, “What does it look like for this year?” And they use that to reduce their 1/15 and 1/31 tax payments.

Drew McLellan:

Right. Of course, yeah. This is-

Mike D’Alessandro:

So they can get money sooner than later.

Drew McLellan:

All right. So I was going to ask about process. Before I do, though, I suspect some people are going, “This sounds great, but when I do this, I’m going to get audited.” So is that true?

Mike D’Alessandro:

It’s a great question. And, we get asked that question all the time.

Drew McLellan:

I have no doubt.

Mike D’Alessandro:

“Hey, I only want to do the open tax year because if I amend, I’m going to get audited.” And I’ll tell you this, the last 14, 15, 16 months, we have done more amended work than I did the first 12 years in this business combined. Combined. It’s amazing that people are less concerned with audit and more …

Drew McLellan:

But, does this-

Mike D’Alessandro:

“Aren’t you worried about an audit?” And they say, “Mike, I’m more worried about-”

Drew McLellan:

Leaving money on the table. Right? But, does doing this increase the likelihood of you being audited?

Mike D’Alessandro:

It does not.

Drew McLellan:

Okay.

Mike D’Alessandro:

And it does not increase the general audit. The general audit stays the same. What may happen is if you fall out of those benchmarks, there might be an IVR, which is called an Information Document Request. There might be a review where they want to just look at the research credit. That’s all they’re looking at. The first company I started with, when I left the company, we had closed our 130th audit. We had 270 other audits open at the time, over 400 audits. Not one of those 400, they looked at anything else. Now, they could. I can’t tell you that they can’t look at it because they can, but they generally send a research credit specialist out. And they’re only looking at the research credit. And really, it’s more of a compliance audit. They want to make sure that you’re doing the work.

Now, there is an IRS Audit Techniques Guide that outlines all of the things that you need to be doing, to file for this credit. So, there’s a quantitative analysis which entails pulling the box one W2’s for all the employees for the last seven years. And then the 1099s that you hired, outside companies and consultants that you used for data analytics.

Drew McLellan:

Because again, you can get credit for that as well, right? It’s not just wages.

Mike D’Alessandro:

It’s not just wages. Also, material and supplies, but we get a list all the time. Trello, GitHub, JIRA. We used all these different tools, all these development tools. So if you’re paying money for development tools, having those, purchasing those tools. If you have a dedicated development server, the cost of that dedicated development server. So, it’s material and supply costs. It’s outside third-party contractors and 1099s. The biggest driver of the credit, 90% is the box one W2’s, and it includes owner’s compensation.

Drew McLellan:

Oh my gosh. I’m telling you that-

Mike D’Alessandro:

So, if you’re an LLC, it’s your self-employment income. It’s not bad, subchapter, s-corporation, it’s your box one W-2 if you’re an owner. So owner’s compensation is included, but, it’s a wage-driven credit. 90% of it is box one W2 wages. So we do the quantitative analysis and we make the reasonable allocations of folks’ time that participated in these qualified projects, and initiatives, and process improvements. And we file for these credits. And then on the back end, the second phase of the project is the qualitative analysis. You have to write a story and that’s what we do. We have a cloud-based, technical report writing platform that outlines the IRS’ Audit Techniques Guide, that mirrors it, that creates nexus between the qualified activities and the qualified expenses.

Drew McLellan:

Yeah, that’s beautiful. So, I’m just-

Mike D’Alessandro:

And to my knowledge, we’re the only company in the country that does that. I can take my iPhone or my Android phone. I could be traveling through a client’s facility. I can take pictures on my phone of a whiteboard. I can take pictures in a manufacturing or food processing facility, and look at a new piece of machinery and equipment, or samples that are being made for a smaller, medium size, fast food franchise, that it’s going to go to their test kitchen. I can take pictures on my iPhone or my Android phone. I can upload it to our clients’ report. I’ve worked for the biggest in the industry. Nobody has the ability. We spent four years putting this cloud-based, technical report writing platform together to help our clients defend these in the event they are ever audited.

Drew McLellan:

I was just going to ask you about the process. So the process, if I understand it right, is A, documenting the time spent or the dollars spent on these activities. So first of all, you have to understand what the activities are, what qualifies for the activities. Right?

Mike D’Alessandro:

Correct.

Drew McLellan:

Then you have to document it. And now it sounds like then I have to write some sort of a narrative that explains what I’ve documented. Correct?

Mike D’Alessandro:

Correct.

Drew McLellan:

And then I file for this credit?

Mike D’Alessandro:

That’s correct. So we, our process is, I always say it’s education identification, qualification, quantification, and then the writing of the technical report. So, we have a whole bunch of foundation documents that we share with our clients and prospective clients. We sign a mutual nondisclosure and confidentiality agreement that goes both ways, to protect the intellectual property that we’re sharing with prospective clients and clients, and the wage and expense information they’re sharing with us. So we do a full phase one analysis with every client, prospective client every year. And we educate them, we identify, qualify, quantify the credit. And then we come back with calculations, work papers, and tax forms, or state tax applications. And we tell them exactly what the credits are going to be. And, at that point, we provide them with a fixed fee quote on what it’s going to cost to do all the work, build out the technical report, and offer unlimited audit support.

So it’s at that point where the clients and prospective clients have all the information they need to make a decision on whether they want to sign an engagement letter or not. So then we also get the tax forms to their CPA to validate the utilization or use of these credits.

Drew McLellan:

Right. So can somebody do this by themselves?

Mike D’Alessandro:

There’s a great example. June of 2017, there was a great digital marketing agency. I wish, I’ll have to go back in my emails, that did it. The controller did it on his own. And they got audited and they threw everything out and they assessed penalties and interest. And one of our really large digital marketing agencies in Camden, New Jersey, the owner sent me the press release with the link that outlined all this. And he said, “Mike, what does this mean for me?” And I said, “You know all the things that we asked you to do every year, the time sheets, the list of projects, the list of all the estimates, quotes, and proposals that you do? All that free consulting?” He said, “Yeah.” I said, “If you read this article you sent me, that agency didn’t do any of this stuff. They just said, ‘Yeah, all of our front end developers, 30%, all of our backend developers, all of our data analytics developers-‘”

Drew McLellan:

Yeah, they didn’t document their case.

Mike D’Alessandro:

Correct. And everyone had the same percentage allocation, even if they were working half the year for a large client that was paying them T&M. Time and materials work is not eligible, because when you’re billing out pure T and M work, who’s at risk? The customer. You’re their R&E, R&D. Right? So there has to be a business risk, economic risk, a risk of failure, cost overruns. And that the solution that you’re trying to deliver isn’t going, isn’t working, performing, or functioning as promised or intended, and you’ve got to redo it. If we can prove all that, most digital marketing agencies say to us, “Yeah. I mean, yeah. We’ve got a scope. Yeah. There’s a fee cap. Yeah. We outline our schedule of fees, but it’s not more than this. And we’re ultimately responsible for this, unless there’s a scope change.” Right? And generally when there’s a scope change, a change order is signed.

Drew McLellan:

I was going to say, you document that, too, right?

Mike D’Alessandro:

Documented, and additional fees are agreed to upfront. Right? And, the marketing agency is at risk at that point, but the writing of the technical report can be done prior to the filing. We’ve been doing more and more of that. Or you can file and we can spend the next month, two months, three months building out the technical report. Most folks think that the technical report has to be submitted with the tax return. It does not. It’s the insurance policy, if anyone ever comes knocking, federal or state.

Drew McLellan:

So is it required or is it just a nice to have?

Mike D’Alessandro:

Oh, no, it’s a requirement, if you want to be able to defend it. You don’t have it? You have what’s called an unsubstantiated credit.

Drew McLellan:

Got it. Okay. And so odds are, that’s when they’re going to come see you. Yeah. If they’re looking for somebody to audit, they’re going to look for somebody first who doesn’t have the proper paperwork.

Mike D’Alessandro:

That’s exactly right. They’re looking for non-compliance. They’re looking for somebody that doesn’t have this available, and it’s not just the IRS and the state revenue agencies. We have been called into clients that are being acquired and they’ve taken the credit on their own. And they want us to come in and substantiate the credit that they took, because the valuation came back and there’s this huge exposure. And they’ve taken a half a million dollars off the selling price, because they’ve taken three years of credit plus the current year, that someone is going to buy and they’re buying that exposure.

Drew McLellan:

Yeah, that’s frightening.

Mike D’Alessandro:

Oh, I always talk about enterprise value. If you’re doing this on your own, you’re losing enterprise value. Meaning that, the first thing that is certified valuation, a CVA is going to do, someone that’s certified to do valuation work is going to say, “Oh, we see you’re taking the federal and state research credit. Can we see the technical report that accompanies that for the last three or four tax years?” If you can’t produce it, that is going to be a footnote. There’s going to be, “Look, the credit was filed with penalties and interest. It could be as much as $81,000 at times X number of years, plus the aggravation factor. We’re advising you to diminish the selling price $400,000.”

Drew McLellan:

Right. Right. Nothing about that sounds good.

Mike D’Alessandro:

Well, it could be a deal killer. It could be a, “Wait a minute. We knew you were taking the credit. We thought it was a substantiated credit. We didn’t know that it was an unsubstantiated credit. As a result, we’re discounting the selling price.”

Drew McLellan:

Yeah. I’m sure people are thinking, “Okay, I totally need to hire a company to do that.” How do you guys get paid?

Mike D’Alessandro:

Well, what we do and that, and that’s a great question. There’s a lot of companies out there that it’s contingency-based. Look, in March 25th, 2008, the IRS put out circular 230, which made contingency billing illegal. But providers have gotten around that by saying, “Hourly, not to exceed 35% of the benefit. Hourly, not to exceed 30% of the benefit.” And the bill magically comes to 38%. They retracted the 35 or 30% and you pay the 30%. What we do upfront is, it’s a fixed fee and there’s a separate fee for audit support, if it’s ever needed. We used to embed the audit support into the fixed fee, but then I thought, “We’re charging for something that a client may never need, may never use. So let’s put a fixed fee and then a fixed fee for unlimited audit support if it’s ever needed.”

So, what we do is, it’s for us is, when you know what the credit is going to be federal and state, we’ll tell you exactly what the fixed fee is going to be. You have all the information you need to say, “Mike, I’m going to get a hundred thousand dollars in credits. It’s going to cost us $20,000. And it could be another $7,500 for a full audit support if a full-blown audit is … ever takes place.”

Drew McLellan:

But I don’t have to pay for it unless I need it?

Mike D’Alessandro:

Right.

Drew McLellan:

Okay, so I pay that fee up front? I’m thinking about like 20% of, or whatever the number is, of a hundred thousand dollars is a good chunk of change. So how does that, how and where does that show up to me as the agency owner?

Mike D’Alessandro:

Well, as far as paying the fee, or as far as?

Drew McLellan:

Yeah.

Mike D’Alessandro:

I mean, look, these technical reports that we’ve written, I mean, we have a very large national client that if I said the name, everybody would know. They have their own computer science department that builds out customizations and integrations. And, it is very comprehensive. And we deliver a technical report that we shave down to 1100 pages. Even some of our smaller clients, they’re in the hundreds of pages. I mean, these technical reports are comprehensive.

Drew McLellan:

Yeah. I’m not questioning the fee. I’m just questioning the timing. Like-

Mike D’Alessandro:

The technical reports are comprehensive. And, I would say on average, we have historically billed below 20% of the fixed fee, and fixed fees vary. I have one client that pays significantly less because it’s a father, two sons, they’re all Master’s degree in engineering. They do all of the qualified activity. They track everything very thoroughly. They have one location. They have less than 10 employees. Their fee is much less.

Drew McLellan:

Sure. Because it’s a less complicated thing. Yeah.

Mike D’Alessandro:

Their fee is $6,000. They have a client with the same credit, it’s $12,000, but there’s five times the number of employees. There’s five different departments. There’s two different locations. Right? So the workload is double. So, it really revolves around, and that’s why for selfish reasons, everybody says, “I can’t believe you do the full analysis upfront,” because the CA the national companies I’ve worked for, we would say, “Drew, you’re going to get between 20 and 40,000. We’re going to charge you hourly and cap it at 35%. Sign the engagement letter. Before we start anything. Before you even understand what we’re going to do.” What we come in and do is, do that full phase one analysis. At the end of it, you have a complete and total understanding of what we’ve done and what we need to do to build the narrative. And, it’s at that point where you have all the information and all the knowledge so you can make a decision on.

When I started RTC in May of 2014, I hated the way that a lot of these national providers operated. And I thought, “If I were a business owner, how would I want to make a decision on doing it?”

Drew McLellan:

Right. Yeah, I think I’d want the information. Yeah.

Mike D’Alessandro:

I would want all the information. I would want to know how much time, what the cost is? What am I getting? What is the process, the full process? And I always tell people, “The first year is the worst year, because you’re learning all this.”

Drew McLellan:

Well, and you probably haven’t documented it in the way you would in future years, once you know how to document it, right?

Mike D’Alessandro:

That’s correct. Our clients get better, and better, and better.

Drew McLellan:

Sure. Of course, and more efficient, and more efficient, I’m sure.

Mike D’Alessandro:

If payrolls are flat for four years, they peak. The credits flat. So, it’s interesting thing about that.

Drew McLellan:

Unfortunately, payrolls have not been consistent and flat, as you know working with agencies, everybody’s paying more for their people. But I hear what you’re saying. You just get smarter about how to document in process, rather than having to go back and sort it all out.

Mike D’Alessandro:

Our clients, that have adopted all of our tools, get the highest return on investment for further time. And for the wages that there are, they’re the most well-documented and highest.

Drew McLellan:

I’m sure.

Mike D’Alessandro:

What we do, we want to know what the W-3 wage is, which is the total of the W2’s because we benchmark hundreds, and hundreds, and hundreds of our clients against each other. And, we have a really good idea where someone is going to fall. It’s just going in there and doing the work to find out forensically, where are they actually at? Our clients call us defensively aggressive. And I have a CFO that, he’s one of my audit references. We went through a federal and state audit with him, and he called me after the audits. He said, “You’re defensively aggressive.” And I said, “Is that an insult? Or is that,” I said, “I can’t figure out if that’s an insult or a compliment.” And he said, Gary Bender’s his name. And Gary said, “Mike, it’s a compliment. I know that RTC won’t take any more than you know that you can defend.”

Drew McLellan:

Right. But, you’re not going to leave a lot on the table. You’re going to go right to the line. Yeah.

Mike D’Alessandro:

We don’t want to do that. And look, the credit is black, it’s white. And there is gray area. And our largest and first client was the third-largest mushroom farm in North America. And I know what you’re thinking. There is a mushroom farm that has-

Drew McLellan:

It has digital, it has computer science, or for them, it’s-

Mike D’Alessandro:

Well for them it’s agricultural science. They also did a tremendous amount in keyword, search engine, digital marketing. What they were able to do from data and analytics was a lot of the school districts in the states, if you eat a hot dog or a hamburger, 25% of that hot dog and hamburger has mushroom proteins in it instead of animal-based proteins. And the kids don’t know the difference, they love it.

Drew McLellan:

So, not only are you helping with tax credits, but look, you’re making America healthier. I love that. Yeah. I love that.

Mike D’Alessandro:

So, this mushroom farm, they’re the third-largest. Monterey is the largest in California. Giorgio Foods, who bought Modern Mushroom is the second largest, and our client is the third largest. Well, we got audited shortly after I started RTC. They were client number one. And the auditor, she came up from the Philadelphia office of the IRS. And the first five sentences that morning were, “I don’t even understand how a mushroom farm even qualifies for this credit.” And I thought, “Oh boy.”

Drew McLellan:

Great, going to be a long day. Right?

Mike D’Alessandro:

This might be like a T-ball game. If you ever go to a T-ball game, it’s the longest hour of your life.

Drew McLellan:

Yeah, right.

Mike D’Alessandro:

I always tell people, “If you only have an hour to live, go to a T-ball game.”

Drew McLellan:

Because, it’s going to take 12 hours. Yeah. Yeah.

Mike D’Alessandro:

It seems like it, but five hours later, she said, and this was after spending time, about an hour a piece with five different departmental leaders. She said, “Now, I understand how a mushroom farm qualifies for this credit.” And the CFO, who’s a CPA. He has a Master’s degree in taxation from Villanova. He runs out of the conference room to his office, across the hall from the conference room. And he comes back with a binder and staples. It’s like six inches, and there’s a 585-page technical report that we wrote for the year in which their auditing, was tax year, 2013. They were auditing ’13, ’12, and ’11, but they picked ’13, the year that we actually did the credit. They did ’12 and ’11 on their own. And they picked ’13 as a representative year. And the auditor said, “What is this?” And the CFO said, “It’s the technical report that Mike and his folks wrote for the credit that you’re auditing.” He said, “You can take it. It’s a copy.” She said, “Are you kidding?”

So this was the 7th of November. And before Thanksgiving, she sent an email, closing the audit, accepting it with no change. And the two years that they did on their own, where they grabbed the credit, but it was much lower than ours. They accepted all three years.

Drew McLellan:

Yeah, good thing they picked the right year.

Mike D’Alessandro:

Well, and that’s a great question, Drew. What they do is they pick the most recent tax year. So you can’t wiggle out of saying, “Well, we switched to Office 365 when we … The PST files, we lost all of our email correspondence.” You can’t really wiggle out of information that’s 18 months, 12 months old.

Drew McLellan:

Right, right. Right, yeah.

Mike D’Alessandro:

So they, for fairness, they pick out what you can recall. They’ve picked a representative year, that’s generally the most current tax year.

Drew McLellan:

Sure. It makes sense. This has been fascinating, Mike. I know that it just can feel, even though this isn’t, I mean, you and I are recording. This won’t air for a while, but I can’t wait to launch this live, because I can just feel the energy of people going, “Oh my God, I didn’t know about this.” So, if people want to learn more about it-

Mike D’Alessandro:

I hope your server doesn’t crash, Drew. I hope your server doesn’t crash.

Drew McLellan:

Yeah. Yeah. Well, thank goodness. It doesn’t sit on my server. It sits on our friends at Google and Apple, and I figured they got us covered. Yeah. So if people want to learn more about this, I know you have a lot of educational material on your website. I know you have a lot of, you said you do webinars and other things. If people want to learn more, or they want to talk to you directly, what’s the best way for them to get in touch with you, to get access to some of your educational materials?

Mike D’Alessandro:

I’m going to say the first thing to do is talk to your CPA. Make sure the biggest hurdle, 90 plus percent of our work is a CPA referring us on. We’re being brought in by the trusted advisor. 90% of our work. The other 10% is C level to C level, CEO to CEO, president to president, CFO to CFO, chief operations officer to just, chief operations officer. Have a conversation with your CPA. Let them know that you’ve found someone that evaluates this and are they receptive in taking the research credit. Because the sooner that we can get your CPA involved and on board, and an active participant in evaluating this credit, the better off knocked up. For us, we have a much higher closing ratio when the CPA is an active participant.

Now, I also want to be very cognizant of the fees that you pay your CPA. Talk to your CPA, tell them that, “Are you okay with us evaluating it internally? If it makes sense, we will bring the results to you.” Some CPAs say, “No, no, I won’t. I’m educating myself. I won’t charge you for going through this with Mike, and Mike’s team.” A lot of our clients pay a fixed fee to their CPA, so it’s not like the meter’s running. So the CPA is actively involved throughout the process. Sometimes they involve the CPA when we know that there’s meat on the bone, so to speak. So I would say first have a conversation with your CPA, making sure that they’re receptive to you evaluating this tax credit. Second, reach out to, we’re at www.researchtaxcreditsllc.com. And email me, [email protected]. But I can’t stress enough, make sure that your CPA, that your tax provider is on board and they’re open and they’re receptive to evaluating this. And then let’s move forward with it, because we don’t understand the individual tax positions of all of our clients.

Drew McLellan:

Of course not. Right? It sounds like it’s an important partnership.

Mike D’Alessandro:

It really is. And I always say, “Our goal isn’t to be …” We don’t have relationship capital with our clients, the CPAs that refer us have that relationship capital. So our job is to make them look like the heroes, not RTC look like the hero, because we don’t have the relationship capital. You don’t look like a hero to someone that you don’t have relationship capital with. So our job is really, the CPA partners that we work with, our job is to make them look good. Right?

Drew McLellan:

Yeah. But, and also to help your ultimate shared client save a lot of money.

Mike D’Alessandro:

Look, any time that you can pay the minimum amount of tax, we’ve done at my former employer, we did a project for Ross Perot, and when we did the analysis and a 35% effective tax rate. And they sent it back and we said, “What? They said, make that 9%.” I said, “9%? Nobody pays 9%.” They said, “We do.” You hear the stories about Warren Buffet pays 11%? Ross Perot Jr. pays 9%. They do that because they do things like this. If they own buildings, or real estate, or have assets, they accelerate the assets. That’s a whole other talk on agencies that actually own their building, is accelerating the depreciation expense on that building. We can talk one-off about that period.

Drew McLellan:

I was going to say, we’ll talk about that offline and have you come back. Yeah.

Mike D’Alessandro:

Could be a whole other tax topic, but it’s, again, it’s being informed, and being educated, and understanding that these tax strategies are out there and they’re available.

Drew McLellan:

Yeah. This has been fascinating, Mike. Thanks for coming on the show. Thanks for sharing your expertise. I cannot wait to get the feedback from this episode. So, thanks. Thanks for being with us.

Mike D’Alessandro:

Thank you, Drew, you’re very welcome. And we are very grateful that you reached out and involved us.

Drew McLellan:

You bet. All right, guys, this wraps up another episode of Build a Better Agency. I tell you almost every episode that I want to bring you actionable information, things that you can put into play. So, first of all, for all of you that are outside of the US, I’m sorry that this is so US centric, but there may be something like this in your country, so I would ask. But for those of you in the US, you’re welcome. I hope all of you explore this, and whether it ultimately ends up that you could qualify or not, it sounds like most of you could at some level. And so, this is free money. Again, even if you’re paying a portion of the tax credit back out in a fee, this is reducing your tax liability. I love the fact that it sits on the books for so long. So, it just gives you some wiggle room, and some breathing room, and some cashflow management tools that you didn’t have before.

So for those of you that had not heard of this before, I hope that this has blown your mind a smidge, and that you’re going to dig into it right away. And for those of you that are already doing it, bravo to you for knowing about it and having a CPA that knows about it.

So here’s the deal. I’ll be back next week with another guest, hopefully to expand your horizons like Mike has. Before I let you go, I of course, want to thank our friends at White Label IQ. They are the presenting sponsor of this podcast. They make sure that I can hang out with you every week. And ultimately, I am just super grateful that you carve out the time to be with us. I know how crazy busy you are. And I’m telling you, I sort of feel like I earned your attention this week. So I’m feeling good about that. But every week when you come back and when I bump into you at conferences or wherever we see each other, or I get an email from you saying that the podcast has been helpful, you just have to know that that means the world to me, and I am grateful that we get to serve you in this way. So thanks for listening. And I’ll see you next week.

That’s all for this episode of AMI’s Build a Better Agency Podcast. Be sure to visit agencymanagementinstitute.com to learn more about our workshops, online courses, and other ways we serve small to mid-sized agencies. Don’t forget to subscribe today, so you don’t miss an episode.