The R&D tax credit also referred to as the credit for enhancing research activities, is a corporate tax incentive that allows businesses to recoup a percentage of their research and development costs. A temporary measure in stimulating economic activity in the year 1981 was the initial purpose of the implementation of this tax credit but this has now become a permanent element of the tax legislation. Claiming R&D tax credits can provide benefits to companies financially, and with the help of an R&D tax credit software, a corporation can maximize its R&D tax credit claims.

Determine the R&D Tax Credit Eligibility of Your Business

If your company invested in research and development in the prior year, then there is a chance that you are eligible for the tax credit since R&D tax credit can be obtained by enterprises regardless of size and industry. It is a frequent misconception that only huge organizations can claim credit. To qualify, your company must have participated in what the Internal Revenue Service (IRS) refers to as QREs or qualified research expenditures.

In general, if your firm has sought to create new goods or processes or has worked to enhance existing products or processes, it will likely qualify for the R&D tax credit. We’ll explore qualifying research expenditures in further detail below.

Four-Part Test in Determining R&D Tax Credit Eligibility

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The four-part test below will help you in determining whether or not your organization is eligible for the federal R&D tax credit as well as the possible benefits that it could provide.  To qualify as eligible research expenses under IRS Section 41, your company’s efforts must fulfill these requirements.

Test #1: The Section 174 Test. With this test, the expenditures must relate to the trade or company of the taxpayer, and it should eliminate any doubt with regards to the creation or the enhancement of a product.

Test #2: The test of technical information discovery. The concepts of physical or biological sciences, engineering, or computer science must be what the test should rely on.

Test #3: The Business component test. Companies must aim to use the found information to produce a new or enhanced business component. The corporation must be able to establish a connection between the claimed research and the applicable business component.

Test #4: Experimentation test. A procedure meant to evaluate one or more alternatives for attaining a result if the capacity or technique for reaching that result, or the proper design for that purpose, is unknown at the outset of the taxpayer’s research operations.

A business must be able to demonstrate that it was able to comply with all four of the tests mentioned above for the research expense to qualify.

Documentary Requirements in R&D Tax Credit Claims

As with any kind of tax credit, correct paperwork is required for getting the advantages of the credit and avoiding the possibility of an audit, thus, in claiming an R&D tax credit, the following documents and records should be submitted:

1. IRS Form 6765 – this is the usual form that the IRS requires when calculating and claiming the research credit
2. A detailed list of R&D activities that meet for the credit according to the above-described four-part test
3. Documentation to support your claim for qualifying research costs, such as wage statements, receipts, and invoices for supplies and other research expenses.
4. Time-tracking data for workers whose W-2 taxable salaries are being claimed for the credit
5. Contracts and other subsidiary data, if any portions of the R&D process were outsourced


How to Enhance Documentation for R&D Tax Credits

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There are several reasons why businesses leave money on the table when submitting for R&D Credit. One of these reasons can be the use of a provider who does not specialize in the credit or a specialist’s determination that there is insufficient paperwork to adequately argue why the activities and related costs qualify for inclusion. It is not unusual, according to Pamela Sommers, senior manager of professional services at Thompson Reuters, for a corporation to leave 10 to 30 percent of its credit unclaimed owing to the expense and complexity of correctly recording it.

Every time you obtain your R&D Credit report describing in detail your R&D process as well as the factors why specific activities were or were not included, one of the most essential aspects of that report will be recommendations for optimizing your future documentation to ensure that no future qualified activities are ignored. Here are two strategies to enhance your R&D Tax Credit documentation and expedite the R&D Credit application process.

• Time Monitoring

It might be difficult to quantify earnings associated with qualified research activity. In the absence of a reliable time-tracking system, the taxpayer must utilize an estimation approach to calculate employee earnings. According to the Research Credit Claims Audit Techniques Guide of the Internal Revenue Service, to meet their burden of proof when adopting the estimation method, the taxpayer must provide factual evidence for each assumption underlying their predictions. With a dependable time-tracking system in place, employees can trace their time to particular projects and activities, establishing a nexus and minimizing the burden of evidence associated with the estimation technique.

Companies that do business with the government frequently employ time tracking. Due to labor being the greatest cost component of a project, the government mandates that these businesses adhere to FAR timekeeping requirements. Even though organizations who engage with the government are more inclined to use time monitoring, other industries can also utilize it to simplify documentation. When it’s time to measure employee wages for the R&D Credit, rather than being extremely conservative with their time estimates and potentially leaving significant money on the table, companies can simply download their time-tracking summary and have confidence in what they’re reporting and peace of mind that the numbers are reliable.

• Create GL Accounts Dedicated to R&D Expenses

One frequent area that needs improvement is quantifying and tracking R&D-related supply and material costs, and more frequently, businesses are tracking all of their supply expenditures to a single general ledger account without distinguishing between R&D-related and general supply costs. This results in the loss of supply and material qualified research expenses (QREs), thus establishing GL accounts for R&D-specific supplier and material expenses guarantees that every dollar spent on R&D is accounted for and your credit is maximized.