To quote Moss Adams CPAs:
"The R&D tax credit is for taxpayers that design, develop, or improve products, processes, techniques, formulas, or software. It’s calculated on the basis of increases in research activities and expenditures—and as a result, it’s intended to reward companies that pursue innovation with increasing investment.
Any company that encounters and resolves technological challenges may be eligible for the R&D tax credit. That said, eligibility depends largely on whether the work a company does meets the criteria established by the IRS’s four-part test.
Four-Part Test
1-Elimination of uncertainty. A company must demonstrate it has attempted to eliminate uncertainty about the development or improvement of a product or process.
2-Process of experimentation. A company must demonstrate—through modeling, simulation, systematic trial and error, or other methods—that it has evaluated alternatives for achieving the desired result.
3-Technological in nature. The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology, or computer science.
4-Qualified purpose. The purpose of the research must be to create a new or improved product or process, resulting in increased performance, function, reliability, or quality."
Moss Adams goes on to say:
"To claim this credit, taxpayers must evaluate and document their research activities contemporaneously to establish the amount of qualified research expenses paid for each qualified research activity. While taxpayers may estimate some research expenses, they must have a factual basis for the assumptions used to create the estimates.
- which activities qualify as Research
-what expenditures within those activities qualify
- what documentation do you have that supports the R&D credits you expect to claim. This would include project lists, project notes, and lab results.
- can you show a clear path that the four IRS criteria are met. Explain.
- have you studied recent [2019] R&D court cases that have decided in favor of the IRS to deny the credit, and can you assure that the client's facts and circumstances would not cause the credit to be denied in the case of an audit?
- If you conclude clearly that R&D eligibility exists, have you evaluated the effect (including financial cost) of potential additional IRS scrutiny?
Submitted by:
Scott Turner CPA
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