Demystifying R&D Tax Credit Documentation

Demystifying R&D Tax Credit Documentation

Posted by Jeffrey Feingold on 12.11.24

Many companies that otherwise would qualify for valuable research and development (R&D) tax credits never bother to apply for them. What would cause a business owner to leave thousands or even millions of dollars on the table? The culprit is often the federal government’s requirements for the documentation of a company’s qualifying activities. While the need for documentation is certainly instrumental to the IRS’ approval process, the lack of understanding about what documentation entails needlessly keeps many out of the R&D credit arena.

Less than 33% of companies that qualify for the federal R&D tax credit actually utilize it, due to misconceptions about qualification and the complexity of necessary documentation. 

Tax Point Advisors expertly guides our clients through the documentation process, taking on much of the work involved in completing that process. Still, we thought it would be helpful to demystify the documentation requirements and alleviate much of the worry that keeps companies from benefitting from R&D credits.

Qualified Research Activities

As we’ve covered frequently in our past blogs, taxpayers applying for R&D tax credits must have hard evidence of why the qualified activities meet the IRS’ four-part test:

  1. Develop a New or Improved Business Component (Product or Process)
    • Create a new or improve an existing…Product, Process, Technique, Formula, Invention, Patent or Software…must also be for sale, license or leased
    • To Improve…Performance, Functionality, Quality, Reliability or Cost
  2. The Activity is Technical in Nature (hard sciences: biology, chemistry, physics, metallurgy, mathematics, etc.)
  3. The Activity Seeks to Eliminate Technical Uncertainty
  4. The Activity Follows a Process of Experimentation

Qualified Research Expenditures

Wages

As the largest component of most R&D claims, documentation of wages includes any payment to a staff member for the qualified R&D work that they conducted. Eligible documentation for payroll includes W2s, payroll registers, interviews, work schedules, morning minutes or other tracking documents that associate the labor costs to the R&D project.

Contracted Research Services

Payments made to third parties for conducting qualified research activities are eligible for R&D tax credits. Good sources of documentation for contracted services include invoices and 1099s, which summarize all payments made to a vendor during a year.

Supplies

Supplies needed to carry out qualified research activities should be backed up by a general ledger with supporting invoices. The general ledger should be sorted by R&D activity for easy access.

Audit Documentation

Tax Point Advisors writes a bullet-proof, audit-defensible R&D tax credit study report for each of our clients. In fact, our audit rate is under 5% and our industry-leading audit success is unmatched. However, if an audit is necessary, it is essential that a business is able to provide documentation that backs up its R&D activity and eligibility. We advise our clients to keep items including lab reports, prototypes, photos that illustrate the progression of testing and assembly, and additional documentation pertaining to industry-specific testing.

See related blog: Will Filing for R&D Credits Increase My Audit Risk?

Find Out if Your Activities Qualify

The R&D tax credit can be a lucrative incentive for innovative businesses. Given the new permanent nature of the federal tax credit, now is the time to consider whether activities performed by your company qualify for major cash-saving tax credit opportunities.

Request a free assessment to determine qualifying R&D tax credit eligibility.

Tax Point Advisors, a firm with expertise in working with small and midsize companies, works with businesses that may qualify for R&D tax benefits. For more information, call us at 800-260-4138 or please leave us a message below.


Fill out my online form.



Latest from the blog

Why CPA Firms Should Partner with an R&D Tax Credit Expert

Read More

Construction Industry: Take Advantage of Savings This Tax Season

Read More

SPECIAL NEWS ALERT:Michigan Enacts R&D Tax Credit

Read More

Contact Us Today for a No Risk Assessment

Get Started