The R&D Tax Credit may be a significant and immediate source of cash for many companies. Recently, issued IRS regulations have made qualifying for the R&D tax credit more appealing to many companies and industries. The new regulations are taxpayer friendly and reflect a profound change in the position of the IRS and state taxing authorities. The new regulations:
- Dramatically broaden the traditional tax definition of “R&D”
- Apply retroactively to prior tax years
- Generate refunds of previously paid federal and state income taxes
- Provide greater flexibility in certain record-keeping/documentation requirements
- Expand the definition of internal-use software
Historically, the majority of companies believed that the R&D Tax Credit study was not applicable to them due to the following:
- “We have not performed any R&D, it doesn’t seem significant and we have no documentation or cost accounting systems to support any qualifying costs.”
- “My company doesn’t perform any R&D. My competitors have similar products and offerings. The R&D Credit is not applicable to my business.”
- “My company is in the financial services industry. We would not qualify for the R&D Credit.”
- “We already claim the R&D credit every year. Why do an R&D Study now?”
- “We performed R&D more in past years. This presents a barrier for claiming the credit today.”
- “The cost of hiring experts to gather the necessary documentation is intrusive and expensive. My employees cannot take time to focus on this.”
- “The R&D tax credit rules seem too complex and not meant for me.”
Many companies overlook qualifying R&D expenditures as defined by the tax law. Many day-to-day operations such as engineering, production, quality assurance, sales, marketing, purchasing and information technology all qualify for the R&D Credit.
If your company is involved in any of the following activities, you may be able to retroactively claim the R&D credit for federal and state income tax purposes, obtain significant cash refunds and establish the methodology to claim the credit in future years:
- Manufacturing products
- Developing new products, processes, formulas, software, techniques, etc.
- Improving existing products, processes, formulas, software, techniques, etc.
- Creating more reliable products, processes, formulas, software, techniques, etc.
- Developing prototypes or models, including computer generated
- Designing tools, jigs, molds, dies
- Applying for patents
- Testing for quality certification
- Testing new concepts
- Sourcing new raw materials
- Developing new technology
- Improving existing or building new facilities
- Employing outside consultants and/or contractors to do any of the above activities
Phase 1 is a High Level feasibility analysis. Specifically it consists of:
- Assessment of R&D expenditures identified for financial reporting purposes;
- Assessment of expenditures considered and documented in previous credit claims and methodology used to accumulate the information, if any;
- Identification, initial examination and interviews with key employees to identify undertakings, divisions, processes, technologies, and division heads where potential qualifying research expenditures may be located;
- Identification of additional opportunities to maximize the R&D credits; and
- Generation of a work plan to efficiently and effectively generate the requisite contemporaneous documentation to substantiate the R&D credits, including a full analysis of all technical issues and detailed itemization of qualifying costs.
Phase II is a more in-depth examination and consists of quantifying, calculating and documenting the credit. During Phase II, the work plan developed in Phase 1 is implemented. As part of the implementation of the work plan, we will continuously test the assumptions used to encompass and categorize the areas of potentially eligible costs to ensure the study is conducted efficiently and that only areas likely to yield significant benefits are pursued. We anticipate the results of this process will guide our overall efforts toward those areas most likely to generate sustainable credits.
Phase III consists of drafting and finalizing the requisite contemporaneous documentation, to substantiate the claimed R&D credits, including a full analysis of all technical issues and detailed itemization of qualifying costs. This will be delivered in our “R&D Study Report”. Phase III also includes the amending of the requisite tax returns which may be prepared by Client’s CPA.
In recent IRS guidance provided to field agents, the Service states that:
“it is essential that whatever method or approach is used by the taxpayer, it must identify
qualified research expenses (QREs) by business component. A significant number of claims are
prepared using a hybrid method that does not properly establish the required nexus between
QREs and qualified research activities. Also, most accounting systems contain information to
identify and measure expenditures without considering whether research and development
activities meet the statutory requirements under the Internal Revenue Code.”
In essence, the IRS is leading its field agents to seek out taxpayer
project management systems that track research expenses by
project while also taking into account whether those projects will
qualify for the R&D tax credit. Furthermore, R&D tax credit
claims that are not adequately supported by contemporaneous
documentation could be issued with a “Notice of Claim
Disallowance” without further investigation.
In response to the IRS guidance for project nexus through contemporaneous documentation, Tax
Projects Group has developed equationASP® to more effectively substantiate the R&D tax
credit. It is a secure, web based, management system that increases audit compliance, decreases
project management costs and drives functional improvements for client companies. This online
system integrates CPAs with their clients and solves the ambiguous requirements of
conducting, calculating and documenting the R&D tax credit.
Click here for more information about equationASP®.
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