R&D Tax Credits Documentation Requirements
Businesses across all industries utilize the research and development (R&D) tax credit to generate tax savings. In order for a business to be eligible to claim R&D tax credits, they must conduct qualified research activities. Once a company satisfies the eligibility threshold, it needs to develop an R&D tax credit documentation requirement strategy in order to assist them in substantiating their research and development tax credit claim. An experienced R&D tax credit advisor is the best resource for businesses to assist them in claiming the R&D tax credit. Contact Clarus R+D to learn if your business is eligible to claim the tax credit and to learn how to develop a meaningful R&D tax credit documentation requirement strategy. Its technology-driven solution empowers companies to fuel their growth with America’s largest tax incentive.
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R&D tax credit documentation requirement overview
Claiming the R &D tax credit is not so daunting for businesses that maintain proper supporting documentation of their qualified research activities. Businesses need to develop a documentation strategy to satisfy the requirements for claiming the R&D tax credits. To claim the R&D tax credit, the taxpayer must contemporaneously evaluate and document their research activities 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. General examples of such documentation include:
- Version control for all technical documents
- Prototypes, including software and physical products
- Test documents
- Developer or engineering notebooks
- Meeting minutes
- Whiteboard photos
- Emails, invoices, receipts
- General ledger notes
- Project notes
- Contractor agreement outlining statement of work
- Other documents a company produces throughout the regular course of business
Having the right supporting documentation makes claiming the R&D tax credit a much simpler process. Clarus R+D will work with you so that you are confident you are maintaining the proper documentation to help you maximize your claimed benefit.
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Record-keeping requirements for the R&D tax credit
There’s no specific record-keeping requirement for the R&D tax credit. Per the tax code and regulations, taxpayers are simply required to retain records in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit. This broad requirement for documentation provides taxpayers with some flexibility in documenting qualified research expenditures.
R&D tax credit documentation for qualified research
Qualified research expenses (QREs) include labor performed for qualified services—tasks performed on projects that meet the four primary qualifying criteria and aren’t specified exclusions. It’s important for a taxpayer to establish a methodology for quantifying wages related to qualified services. The preferred method for quantifying wages is a time tracking system that tracks qualified research hours to qualified projects. This enables a taxpayer to create a nexus between qualified research activities (QRAs) and QREs. There are instances when a time and tracking system is not utilized by the taxpayer. Estimates of time may be accepted. Estimation methods are permitted in cases where the sole issue is the exact amount paid or incurred in the QRA. Accordingly, taxpayers should maintain factual support for the assumptions underlying the time estimates to meet the IRS burden of proof. Taxpayers are only allowed to include taxable wages in the R&D tax credit calculation. Non-taxable items, such as 401(k) contributions, health insurance contributions, and other pre-tax benefit deductions, should be excluded. The following are examples of the types of documentation that can be used to substantiate qualified research wages:
- Employee W-2s
- Payroll registers
- Time tracking data
- Time questionnaires
- Interview notes for oral testimony
- Job descriptions
- Meeting minutes
- Documented qualified supply expenses
The Internal Revenue Code defines qualified supplies as any tangible personal property used in the conduct of QRAs, except property of a character subject to the allowance for depreciation. Examples of qualified supplies include components used to fabricate and test prototypes, raw materials used during product or process design, or testing and scrapped material resulting from QRAs. Utility expenses are considered general and administrative expenses; however, if you can prove the research required an extraordinary amount of utilities, you can include an appropriate amount. The following are examples of the types of documentation that can be used to substantiate qualified supply expenses:
- Chart of accounts
- General ledger
- Purchase orders
Taxpayers should track or allocate qualified supply expenses to applicable qualified business components if possible.
Contract research expenses can equate to 65 percent of any amount paid or incurred by the company for qualifying research activities carried out by a business or person other than an employee of the company. The actual work concerning contracted research must be carried out in the United States and its territories. Examples of contracted research expenses include the invoiced fees regarding the following:
- Engineering consultants
- Subcontractors used to operate prototype process system during development
- Contracted testing laboratories
The location of the third party is important in establishing QREs. The federal R&D tax credit requires the research and development activities to be conducted within the United States. States that offer state-level R&D tax credits require the R&D to be conducted within their respective states. All offshore R&D should be excluded from consideration. The following are examples of the types of documentation that can be used to substantiate qualified contract research expenses:
- Chart of accounts
- General ledger
- Third-party contracts
- Purchase orders Invoices
- Form 1099 (for individual contractors)
Taxpayers should track or allocate contract research expenses to applicable qualified business components if possible.
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The R&D tax credit program is an immensely valuable resource which can help your business innovate and grow.Sham Mustafa / Correlation One
R&D tax credit documentation: The IRS areas of concern
The IRS’s preferred method for capturing QREs is a project-based approach where taxpayers create nexus between QREs and QRAs. Taxpayers aren’t required to provide a factual nexus bridge between claimed QREs and specific business components as long as there’s reliable evidence to support the QREs. The creation of nexus between QREs and QRAs generally is most difficult with respect to capturing qualified wages. Taxpayers should attempt to create nexus between QREs and QRAs when possible. The use of high-level estimates can make it difficult to substantiate an R&D tax credit claim. High-level estimates can include the use of interviews to estimate R&D time percentages and judgment samples. A common example is a chief financial officer or chief executive officer making R&D time percentage estimates for everyone in the organization and not consulting with those individuals closer to the QRAs. Taxpayers should expect to retain additional supporting documentation for high-level employees involved in R&D.
The R&D tax credit calculation is a percentage of the current-year QREs over a base amount. The base amount is calculated using prior-year QREs. Taxpayers are required to maintain consistency in the calculation and must demonstrate consistency between QREs in the credit year and QREs in the base period years. For example, if a taxpayer claims a certain type of expense as QREs in the current year that it never previously treated as QREs, then it must adjust its base period QREs to reflect the inclusion of this type of expense. Taxpayers also are required to make base period adjustments for any acquisitions or dispositions made during the tax year. Acquisitions and dispositions can have a tremendous effect on the final credit result, and the IRS commonly asks about acquisitions and dispositions during exams.
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Eligibility and the R&D tax credit documentation requirements
Not only is it important to develop a documentation strategy, but it is also necessary to work with an experienced R&D tax credit advisor, like Clarus R+D, to help you determine your R&D tax credit eligibility. In order to be eligible for the research and development tax credit, your business must engage in qualified research. Qualified research generally is private sector or commercially driven development intended to yield innovation within a scientific or technological field. The following four-part test determines whether an activity is considered qualified research and, thus, eligible for the R&D tax credit.
The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component. A business component is defined as any product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.
Elimination of Uncertainty
The taxpayer must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development or improvement, or the appropriateness of the business component’s design.
Process of Experimentation
The taxpayer must undergo a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer’s research activities. Treasury Regulations define this as broadly as conventional implementation of the scientific method to something as informal as systematic trial and error process.
Technological in Nature
The process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement. Research activities that qualify for R&D tax credits must be conducted in the U.S. If your business does any of the following, it likely qualifies for the R&D tax credit:
- Develops or designs new products or processes
- Enhances existing products or processes
- Develops or improves upon existing prototypes and software
Clarus R+D will work with you to help you understand what is considered qualified research for purposes of determining R&D tax credit eligibility.
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R&D tax credit consultants: What to expect
Whether you are in the process of developing an R&D tax credit strategy or looking for assistance in determining your eligibility, working with an R&D tax credit advisor like Clarus R+D has many advantages. Here is what you can expect by selecting Clarus R+D as your R&D tax credit consultants:
- Clarus R+D provides a team of professionals with expert credentials able to answer all your R&D tax credit questions.
- Our proprietary software streamlines R&D studies which maximizes your ROI.
- Clarus has expert knowledge of the IRS regulations relating to the research and development tax credit, IRC Section 41, as well as the regulations pertaining to state-specific research and development credits.
- Clarus has extensive experience in recognizing qualified research activities and expenditures.
- Our time-proven methodology has yielded maximum benefits to our clients.
- The Clarus team has helped hundreds of clients claim millions in R&D tax credits.
- We place emphasis on helping growth businesses take advantage of the tax incentive.
- Clarus does the work for you; our web-based app allows you to enter information at your own pace.
- We have extensive IRS and state audit experience and provide our clients with audit support.
- We have maintained an exceptional success rate in applying for the R&D tax credit.
- We work directly with our clients and their respective accounting firm and payroll processor.
- Our process saves valuable time and resources within the engineering and finance departments.
- Our fees are very competitive.
- Our performance, success rate, and unparalleled quality of service result in high client loyalty.
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ABOUT CLARUS R+DWith custom software backed by a team of tax experts, Clarus R+D specializes in tax credits for growth businesses. Our technology-driven solution simplifies the process, maximizes benefit, and ensures compliance. We partner with accounting firms, financial advisors, investors, payroll providers, and more.