Cost Segregation and R&D Credit Specialization with Craig Fouts

Hello and welcome to the Big Four Transparency podcast. I am joined today by Craig Fouts, a partner at Align Tax Consulting. Welcome to the pod, Craig. Yeah. Thanks, Don. I'm happy to be here and appreciate you having me on, so looking forward to a good conversation today. Yeah. So you were, you were connected with, I think it was Owen, right? Owen and Steve from, from Evans May? Exactly. Yeah. So I believe Owen introduced us. So great guys at Evans May. Really, really cool to see what they're building there. It's totally different from a lot of CPA firms that I've worked with and excited for those two and everything they have going on. Yeah. Yeah. No, I really liked their kind of mentality about the industry. So if you haven't listened to that one, go check it out. But today we're going to focus more on what you are and what you've got going on. So you mentioned, you know, one of the firms that you really like working with, which is kind of a little bit of a hint at what Align does. So to my understanding, you can add to this, but Align is a firm mostly specialized in R&D tax credits as well as cost segregation, specialty work. And so your main client base, I would imagine is pretty much coming through subcontracting with existing firms. Is that right? Yeah. You nailed it. So yeah, we're a specialty tax firm. Two of our main practices are R&D and cost segregation. We do a few other things as well on sales and use tax, work for manufacturers, but then some other just general fixed asset consulting work. But you nailed it. We work with CPA firms across the US, anywhere from sole proprietors all the way up to 50 plus partner firms. So, you know, really a nice range there, just offering what we can to firms that don't do what we do in-house. Yeah. And how does one kind of find themselves in that specialty area, right? Because in school, I mean, to me it was like, do you want to do tax or do you want to do audit? You know, and that's typically kind of what you're presented with. So I'm curious for the journey that led you into that. And then also like, why did you sort of choose that as a path? What are some of the unique advantages of that route? Yeah. It's funny you bring that up. You know, I think everyone just kind of falls into specialty tax. You know, you go to school and they don't teach about cost segregation or R&D tax credits in school, right? Or when you go to college, you know, I know we had a couple of classes on depreciation and I think they maybe brought up the R&D credit in one slide in one class, but I kind of just fell into it. You know, I went to school to go be an accountant. I always thought I'd just do the public accounting route, go audit tax, maybe for a few years. If I like it, stick with it, right? If I don't, go to industry. But as I was going into my year, extra year to go get my 150, I ended up getting an internship with a specialty tax firm based out of Indianapolis and worked on the cost seg team there. Really enjoyed it. It was a ton of fun. You know, at that time I was 22. So part of what cost seg is, you have to go see properties. So I was able to go travel all summer. You know, I had a really fun first trip of going to Washington DC and seeing all the sites and we maybe took an hour of our time there to go look at this building. But other than that, I was like eating and drinking and going and seeing the sites. So that really lured me in. And since then, just really grew with that firm. I was able to go see a lot more cool types of properties and businesses where people are building these huge manufacturing plants or office buildings. So it was really cool just to go see the different parts of the US and different types of businesses. And at that point, I've been doing this just for over a decade now and I've come to love it. I'm a total depreciation nerd. So I just kind of stuck with it. It's been... Yeah. So what I'm looking forward to is just seeing how people are able to use what we offer to help grow their firms and their businesses and utilize our services in that way. Yeah. And so you actually got brought on as a partner in Align. And my understanding is it was basically with the goal of expanding the service offering and you had sort of that unique experience in the cost segregation area specifically. Do you know a little bit about like kind of the strategy of Align? Why focus on all these kind of specialty areas and not necessarily on the core of tax work itself? Is there a specific strategy or kind of edge that that offers to the firm? Yeah. It's a great question. My partner Ryan was already in a specialty area doing a lot of sales and use tax work for manufacturers. He had owned real estate as well. So my previous firm, we did a couple of cost seg studies for him. He's familiar with it. He saw how powerful it can be. And his brother is also pretty big in the real estate as well and does a lot of that different type of work. And he had just noticed that there's just such a need for it in the marketplace where basically no one... His entire network of real estate investors had no idea it even existed or what it does to help people. And I think the light bulb just went off for him one day. So he had bought a website. I think it was like costsegregationreports.com or something like that. And realized he wanted to get in the business but didn't have anyone really to run it. So just like you mentioned in your episode you just published, where you have your Rolodex. You're just keeping tabs on people and taking them out, seeing if maybe they ever want to venture out, do their own thing, etc. He did that exact same thing to me. My old firm, I wasn't happy. I was ready for a change of pace and I wanted to come back home in Indiana. I was living in Atlanta at the time and he had called me and just out of the blue, he was like, I know there's no way you're probably interested, but I'm going to take a one-in-a-million shot. Are you interested in joining the firm and expanding our services? And I said, absolutely. Let's go. When do we start? And it's been great. We started running from there and it's been a blast ever since to build it. We actually just celebrated our one-year anniversary earlier this month. So exciting times. That's awesome. I love the story of someone just sort of taking that shot, right? You never know what people got going on. So other than the desire to return back to Indiana, what was the driving factor behind to go out on an adventure of joining a smaller practice like that? Because I think where you were before was pretty established in that space, right? Yeah. It was an extremely established practice. We had clients in all 50 states. We were doing about 1,800 to 2,000 studies a year. So we had a large team, multiple teams across the country. So we were established and it was a good gig and I did have a bright future there. But at the end of the day, I knew it wasn't the right fit for me and what I want to do with my life. And I had always just known I like small business. I come from a family who has a small business. I enjoy the hustle and bustle of wearing multiple hats and the grind, essentially. And as I more thought about it, at the time, I was 30 years old, I don't have any kids, I'm not married yet, right? I was like, I think I can take a risk. It's time to take a chance. Right, exactly. And I talked to my parents quite a bit about it and a couple of my mentors and everyone gave me the exact same answer. It was, you can always go find a job, right? Yeah. So it's been cool just to take the leap into entrepreneurship. It's been, I always like to say, the most exciting but the most challenging thing I've ever done in my life. I think you can probably relate to that. For sure. Yeah. The first few months were challenging. Just waking up with the, I like to call it entrepreneurial self-doubt. Everyone has it. Just not knowing if you're doing the right things on a daily basis. And eventually, you start to see things click though and clients starting to come in the door and you can start to see everything start to build from your vision. And from there, it's a lot of fun, right? You just keep grinding the momentum and keep your foot on the gas. Yeah. So what is the sales motion look like for you? Because again, like we mentioned, you're getting most of your business from other firms and whether that's subcontracting or a referral or something like that to a client in a broader scope of a tax project. Where are you meeting these other firms? What does that arrangement look like? Is it usually just sort of like a goodwill? You refer some folks over to them for other core accounting services that you're not offering and they return the favor or is it usually sort of like a revenue stream both ways in terms of referrals? Yeah, it's a little bit of all that. In the accounting world, it is heavily a referral business and relationship business. So unfortunately, at least leaving my other firm, I had some pretty strict non-solicits. So did not take any clients with us or anything like that. So we had to start from ground zero. And what we did is basically a lot of cold calling, cold emailing, had some good starting relationships there. Then we also just had some relationships within my network. I was able to build off of that and utilize at my old firm. And from there, just let the web grow. So it's been wonderful. I have a few great mentors too that have made a lot of great introductions. So really, we're building as we can. We're trying to scale pretty quickly. But at the same time, you got to find your way into the door somehow. And I've found that building trusted relationships with CPA firms, once you have that trust relationship, it's pretty easy to go in there and say, Hey, Karen from XX firm. Hey, I noticed you guys are pretty close or work pretty closely with this firm over here and the same association as this firm over here. Would you mind giving us an introduction and every time... I've never had anyone tell me no. So I'm just trying to work my way through those and catching them when they are busy, which is a very few times of the year. But yeah. So really, just going all channels, just trying to make sure we're building from a relationship standpoint and a value standpoint. We work with firms in many different capacities too, like you mentioned. We have firms that use us as a revenue source, no doubt about it, where they're able to make a decent amount of money depending on the number of referrals they send our way. But then we also have just a number of firms too that just want to take care of their clients and just want to make sure their clients are in very good taxable positions and saving money where they can. So it's all across the board. Everyone's different. Everyone has different motivations. But at the end of the day, we all have the common goal of taking care of the client, making sure they're utilizing every credit or deduction available to them. Okay. And are you in a lot of maybe like firm alliances or like communities or going to conferences to meet these people or again, sort of cold outreach type of approach? Yeah. So we're starting to build into those different conferences, communities. It's a lot of those, right? It's got to meet someone and work with some firms in those different areas to be able to, I'd say, get access into that. But yeah, so I'd say the majority of our work comes from different accounting communities and conferences. We go to several different, you know, AICPA conferences and accounting conferences across the US every year. And that's a great way for us just to meet people and build contacts. And are you like within the cost seg type of work, are you traveling a lot? Like is this a job where people who want to see the country like should consider or has technology sort of taken that place? Because there are a couple of cost seg firms that I know of who aren't necessarily like in the CPA realm, you know, like it's kind of more someone from like a construction background who started like a cost segregation business or something like that. And I've heard of some places, you know, doing kind of like FaceTime walkthroughs or drone flyovers or things like that. How does that work for you? Yeah, our team is all over the place, everywhere, all the time. So we do go see every property that we can. There are a lot of firms, like you mentioned, doing the FaceTime walkthroughs or having people take pictures. From my standpoint, I know that when you go visit the property and document everything in person, you know, take what you can take pictures of what you need to. I know that's defendable under audit. That's the way we run our firm. However, there are a ton of firms trying to do the virtual walkthroughs. Not saying it's right or wrong, it's just we're not there yet. I'd like to see a little bit more evidence of it being defended under audit or defendable under audit to be able to increase my comfort level there. So it's funny, you know, I've actually been to all 50 states from cost seg, just traveling everywhere going to various properties. But you know, the story I always love to tell about our firm is our very first project was in Guam. So we got a phone call just from a random CPA we called out in Arizona and he says, Hey, you know, I have this multinational business client that he operates in the United States, but he has family in Guam and owns a laundry facility there. So he can help out his family and employ a lot of people in the building. Would you guys mind doing the cost seg study on it? We're like, absolutely. Let's do it. So we got very lucky with that. That one though, they gave us a full set of blueprints. So we had exact measurements of everything going on with the property and did not have to fly 49 hours out to Guam to go see a 7,000 square foot building. But you know, that's the exception. But it's just funny, of all the places to be able to go do a cost seg study, Guam was our firm's very first project. Yeah, that's really funny. Actually, I like that. And I mean, yeah, there's always going to be, you know, appetite for a different scope and different level of reliability of offerings, right? Like I forget who, someone very recently I was reading a post they had made and they were talking about, yeah, some people choose their tax pro based off of how much tax fraud are they willing to let me commit and sign off on basically, right? Whereas other people, it's more about actual certainty, you know, knowing that you're on side, never panicking when you get a letter in the mail from the IRS or whatever, just knowing that you have done the right thing and you are on side. So, you know, there's always going to be shortcuts. There's always going to be kind of differences. I don't know enough about cost seg specifically to comment on which one's better. But yeah, right. There's always going to be a different risk appetite and a different kind of level of comfort with that, which is really interesting. Everyone has their own comfort levels, right? And you nailed it. There's people that want to be a little bit more aggressive and there's the ultra conservative people. At the end of the day, as I'm signing off on these reports though, I'd like to say I'm more conservative. Yeah. I always like to say we teeter a line, we never step over the line. So we want to make sure we're not cutting or getting people short of what they should be utilizing in our reports. But I certainly don't want to be putting them in a risk position that I know that we wouldn't be able to uphold if it were a challenge under audit. Yeah. And so does this look a lot like kind of like inventory counts, like you're walking through a property like, oh, okay, this is this type of window or whatever. What does that actually look like in practice? What are you looking for? And then are there any like tech tools that have come a long way in terms of maybe like building out amortization schedules, like tracking of all the hard assets? Yeah, absolutely. So it's funny, it's a mixture or a beautiful blend of construction engineering knowledge and tax knowledge, right? So yeah, as we're walking the site, that's where a lot of the construction knowledge and skills come into play where you nailed it. I mean, we're essentially doing a full inventory or full appraisal of the property. So when we walk through, we're going to be measuring all the different flooring, all the carpeting, cabinetry, the window blinds, we're taking a look at the electrical systems, the number of outlets going to computers or copiers or manufacturing equipment, you name it, whatever is there, we're taking account of it. We've built a process over the years of being able to efficiently walk through these properties and be able to measure things through just different tactics that we've learned so that we can go and complete a 180,000 square foot building in a few hours. So we definitely have an efficient way of going through it. And then once we do that, essentially, we will go and put a report together that breaks the building down all its different components from ground up. So starting with your foundation, slabs, walls, roofs, windows, electrical systems, you name it. We quantify all those different assets, put a value to all those different assets, and then we properly classify each of those assets in their depreciable life. And that's where all the tax side comes into play, where knowing whether it should be in that 5, 7, 15, 27 and a half, or 39 year life. So it's a very unique skill set that you have to learn. Most people that we bring in, they're either an accountant by trade and know a lot, and they can pick a lot of the tax stuff up pretty quickly, but then we got to teach the construction engineering side to them and vice versa. So if we bring in a lot of construction people, they can pick up a lot of the building stuff pretty quickly, but then you have to teach all the tax stuff to them. So very rarely do we come in and find that you'll call unicorn of someone who knows exactly a lot of this stuff or has experience in both different fields. Yeah. So that's what I was going to ask is like, who's your employee base necessarily? Like is it, I guess it maybe ends up being sort of half and half, like half accountants, half maybe people more from like the trades background or like, what does that look like? Yeah. Ideally, we'd like to have a nice blended team with backgrounds of engineering, construction, or tax, or just general accounting knowledge. That really helps kind of give us a nice, well-rounded team that can lean on each other and you can give different types of projects to each of those depending on if it's a little bit more tax complex or construction complex type situations. And really what we do, I always like to say this as we bring people in, is I ask two skill sets of people or two traits of people is if they're just willing to learn and willing to work hard, you can teach them cost seg or R&D credits or utility sales tax exemptions. Really everything we do is learning on the job. It's almost like an apprenticeship where you can... We're going to show you day one on how to walk through a property and account for things or how to put a report together or how to enter everything into our model and how to do it efficiently. And then from there, you can learn 90% of what we do pretty quickly, probably within a year or so. But we always like to say there's an extra 10% there of a lot of the more complex type, we'll call projects or tax situations, where the art of cost seg and R&D come in, where it takes years and years to gain that knowledge and understand how to put those things together. Yeah. Well, I imagine for R&D as well, there's probably a level of judgment that you need to develop as well, right? Like I've spoken to some, you know, in Canada, we have this program on R&D called TREAD, which is significant. And I've spoken to some people in this who just as you explain to them your business, they immediately are like, okay, this is defensible, this is defensible. costs of development on this thing. You know, if you pivoted the framing of how you're doing this by that much, like you could probably make a claim against it. So I think there is like, you know, there's, there's an understanding of it and an ability to kind of do some of the work. But then I think there's like a mastery of it where it's like you really understand what's going to fly and what's not going to fly, maybe a little bit more up for interpretation when it comes to R&D than cost seg specifically, right? Yeah, both have their subjectivities. Absolutely. Both have similarities in the point of, or in the fact that they're both based on case law. So you can't just go into the tax guides or ref prox or code and say, this is exactly how it should be. Oftentimes you have to go in and understand and read through prior court cases and in case law to understand position to be able to take maybe that situation and apply to what you're doing. So in exactly like you just mentioned, right? Where it's like, Hey, if you take this position on supplies or this position on this person's salary or wages or of what the role is saying that the, you know, maybe the chief marketing officer is, spends 90% of their time in research is probably an aggressive position, right? Yeah. And knowing that's not going to fly because there's certainly court cases to show that's not going to fly. So being able to understand those court cases, apply that, those concepts and being able to use that to defend your work to the IRS, if you were to get challenged, that's where the art of specialty tax comes in. And that's where, you know, you, you separate yourself as an expert in the industry, being able to do so defend positions that, you know, maybe some others aren't able to. Yeah. That's really cool. I like that kind of like blend of like, it's, you know, there's different types of people who go into accounting for sure, but like the stereotypical accountant, like that wouldn't be for me, but like, I know some accountants who are a little bit more, you know, handyman type, like a little bit more sort of like blue collar core. Whereas I think this is like a super interesting crossover of that where it's, yeah, you got to get into the machinery. I'm sure a lot of these are probably manufacturing plants and, you know, maybe farm agriculture type properties. So it's like, it's a cool way to blend those interests with like an expertise in accounting, which I find, I find fascinating. I love finding these different avenues, like there's somewhere for everyone in, in this sort of industry. And this is, you know, a place for people who maybe they, they just don't quite get what they're looking for out of like the core accounting work, which I find interesting. Pivoting a little bit, have there been any big changes with like R&D and cost segregation work with the OBBVA? Because I know, you know, depreciation was a pretty key element in there. And so I'm kind of curious to know what's, what's developed and what's changed and also how that's influenced your business. Yeah. Two major changes, you know, both with R&D and with, through depreciation. First, you know, with depreciation prior, there's this thing called bonus depreciation, which is essentially an initiative or an incentive given after 9-11 to help stimulate the economy. So really it's designed for business owners to invest in property and the initiative or incentive to do that is that, you know, if they were to go buy this machinery equipment or invest in this property, they're able to write off a certain portion of that year one. Since 01, every year has had a different percentage ranging from zero to a hundred percent. So with the OBBVA, a hundred percent bonus depreciation is back. So it's a fantastic thing for real estate investors and what that means for real estate investors, right? So they buy a property and they get a cost segregation study done. Anything they can move into that five, seven or 15 year bucket can be entirely written off year one. Okay. So, you know, a big hot topic for like syndication groups. They're able to give their investors year one, you know, they like to call them paper losses, but year one losses through depreciation. So you know, these investors are able to offset maybe some other passive income that they have to lower their tax bill. So that's been very great. Both changes with R&D and depreciation, it's wonderful for our business. We've seen a huge uptick in activity from it, which is pretty great. The other change I would say is probably the most significant change in the tax bill is the change to the amortization of R&D expenses. So previously you had to amortize R&D expenses over a five year period for anything domestically spent and then 15 years if it was on foreign territory. So it changed to the fact that we no longer have to amortize over five years for R&D expenses. You can immediately expense it again. Which is huge for investment for sure. So it's... Your huge companies have R&D expenses. It was really a timing play on cash for them, on amortization. But for a lot of the people that Align serves, which is your lower to middle market type firms, it was a big deal. I mean, if you're in a startup phase for a company, or if you are pretty capital-heavy investment and you really struggle with cash in your business, those burdens on those tax bills really, really impacted companies pretty negatively for a while. Yeah. Well, that could change the timing of when you need to do an equity raise too, right? And things like that, where maybe you need to raise more sooner and so you end up diluting yourself more than you would want to. Exactly. Some of these actually have pretty huge implications when you look at it that way. Exactly. It did. I mean, if you're a couple million dollar firm and you weren't expecting a tax bill and all of a sudden you have a $500,000, $600,000 tax bill, what are you gonna do, right? You have a couple options. You need to go take a loan, go raise equity and dilute your ownership, or close doors. I mean, those are your options. So it was a pretty huge impact. But glad that that changes back. It makes the R&D credit even more powerful now. So we've seen a lot more activity with that as well. And it's good to see people starting to want to invest and have that incentive to invest in research. Yeah. Is a lot of what you have to do for building those relationships with tax firms, is there a lot of informing that's necessary? Because to me, again, I was not in that area specifically. And I did my tax work at a big four. So, you're a little bit siloed in your area of expertise and someone else would handle that entirely. But if I were to kick up a tax practice, I don't know that I would have the immediate instinct of saying, oh, I need to recommend to my clients that they go do this study. Is there a lot of lack of knowledge and information on that front? Or do you find firms are pretty on top of it? It's a mixed bag. So I think most CPAs or tax CPAs, I'd say are generalists. So I'd say 99% are aware of the credit or cost segregation studies. And they know of it. I'd say a lot of times they know how to recognize it. But when you really get into the intricate details or the nitty gritties of it, that's where they can rely. We have the education process of being able to rely on us. We're able to provide different strategies or show different things in the code of how they're able to utilize depreciation or the R&D credit. Or, hey, here's how you fill out form 3115 for cost seg or form 6765 for R&D. We're able to help educate them on that front. And then also with just tax updates. CPAs have so many different areas of tax they need to stay up on for their clients, whether it be from an individual perspective or from a business perspective. If we're able to just to come in and give them a quick update and just simply break down of what's changed, how we can help or what they need to be aware of, that's a huge thing for them. And a lot of our CPA clients love that. I'll just send over a small snippet of what I've seen or something I know can apply to their situation. And every time, they're super thankful and say they keep them coming. So being able just to keep CPAs updated on the, I would say, more of the complex areas rather than the general areas of what we do is a huge aspect. And again, it's a great way to help separate yourself as an expert in the industry. Showing and being that trusted advisor of, hey, I have this client in a particular situation. What do we do? And you're the person they call about that. So being able to establish that relationship of just knowing and say, hey, I have a real estate client. They have a huge tax bill. Here's what their portfolio looks like. Do we have any options to help knock this one-time gain down? And then we're able to come in and show, yeah, hey, you can do a cost seg on this property. Or hey, it looks like they underreported some 5, 7, 15-year assets or misclassified things over here. Let's speed those depreciations up. So there's just a lot of stuff we can do and come in and help people on that front. So we like to be just more of that back office resource where they can lean on us and not have to worry about spending those hours doing research on cost segregation court cases or depreciation court cases or R&D court cases. We want to be able to say, hey, we've dealt with this before. We know exactly how we can help. Here's what you do. Yeah. Yeah. I mean, there's so much noise already for like if you're the sort of generalist firm or even if you do have a niche or something like that, right? Like it's, yeah, stay on top of your own tax legislation changes and then stay on top of technology changes. What's going on with AI? What process improvements can we do? Like it's a lot to then ask someone to actually make a judgment call on does this fly or does this not fly, right? So I mean, I'm a huge believer in specialization and there can be a bigger pie if you're willing to just share parts of your business that maybe you don't want to focus on with others who can become the absolute specialists in this. I think that's obviously better for everyone. Yeah. And I think a big piece of it too is time. I mean, you look at the public accounting world today and there's so much demand for what the labor is in the marketplace, especially in the small and medium-sized business or lower middle market type areas. And the one thing CPAs are just running out of is time. And if we can make sure we're helping either free up their time or they're able to help bring value to their clients without adding more compliance or time to their plates, I think that is a big deal for them. Yeah. Because right now there's just people... There's just too many clients for what's out there. So it's a good time to be in tax, but it can be stressful for CPOs who are either overburdened or trying to keep up with the workload. For sure. Yeah. Well, I mean, we got a lot of accountants watching. So if this is something that comes up, if you're working with people with some property, specialized machinery, anything in the R&D space and you don't have that time, make sure you get in touch with Craig. And yeah, thanks a ton for taking the time and shedding some light on this area of the industry that maybe some of us don't know too much about. Yeah. I always like to shed light on the public accounting adjacent industry. So I always love to call it. So Dom, appreciate you having me on. It was great talking with you.