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:
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.
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.
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.