Documentation Requirements for the R&D Tax Credit—Qualifying Activities - Advanta Tax Advisors, LLC

Documentation Requirements for the R&D Tax Credit—Qualifying Activities

  Posted November 20, 2019 at 04:00 PM

How much documentation is required to claim the R&D tax credit? This question arises often as taxpayers usually believe their organization does not have documentation that is strong enough to claim the credit.  We will address the documentation requirements at a high level to support the qualifying nature of the activities. 

Taxpayer documents are never perfect. Even in large organizations, documents rarely spell out the information needed to determine if the four-part test under IRC Sec. 41 is met. The documents usually support but do not explain that technical uncertainty exists and the process of experimentation undertaken to overcome the uncertainty.

The quality and quantity of documents vary by industry, company size and level of regulation in the industry. Documents do not have to be in the form of formal reports but may be handwritten notes, drawings, photos, software architecture documents and user stories.

The critical step is to discuss the qualifying activity with the technical personnel to determine whether technical uncertainty exists and understand the analysis constituting the process of experimentation and the principles of science applied. The package available for the IRS should consist of a report written to explain the timeline of the project and how the research activities in the subject year meet the requirements under IRC Sec. 41. The documents should be referenced in the explanation and provided as exhibits. 

We were meeting with an IRS examiner on our client’s case when a decision was issued in a United States Tax Court case. The taxpayer lost the research credit due to lack of support.  Siemer Milling Company v. Commissioner (T.C. Memo 2019-37). The agent explained that a taxpayer does not have qualifying R&D just because they state it and that there must be some documentation. We settled our case that day with the taxpayer sustaining 90% of its R&D tax credit. Our taxpayer’s documents discussed included drawings by hand, regulatory correspondence, proposals and reports from vendors, protocols and test results. A third party cannot understand the R&D process from the documents alone, but the report explained the documents and how they fit in the R&D story.

Documentation generally exists, it just is not in the form that one may be looking for to support the R&D credit. Our engineers interpret the detail in drawings and calculations and our software development experts understand software development processes and common technologies utilized today. Our experts are invaluable in developing the research credit report with little time from the client’s technical personnel.

We help clients navigate the documentation requirements whether you are outsourcing the R&D tax credit work or seeking advice to complete the work in house. Contact us at 678.638.6131.