We talk a lot about proper documentation and how a project can qualify for R&D tax credit audit.
While the amount of direction given by Treasury with regards to projects that will qualify, the Internal Revenue Code does have a section devoted to the types of projects that are specifically excluded from qualifying for research tax credits.
These eight categories are specifically stated in IRC Section 41(d)(4):
Research after commercial production – once it has been determined that a business component is ready for commercial production, technically, research and development (as defined in the Internal Revenue Code) is finished. Any expenses incurred after the start of commercial production would not be includable in your qualified research expenses.
However, as many people know, innovation always brings new improvements to products, formulas, software and other new business components that are function in nature. These new development efforts are considered a new business component and should be broken out separately in your documentation to track and quantify costs, time and tasks.
Adaptation of existing business components – slight changes or alterations for a specific customer that do not have technical uncertainties are excluded from qualified R&D.
However, improvements that require a new development effort where there is technical uncertainty and a process of experimentation may qualify the development effort as qualified R&D. A key point here is the need to have technical uncertainty (as well as demonstrate a process of experimentation) in order to be considered a new business component.
Duplication of an existing business component – it would seem pretty straightforward that efforts to reproduce a second (or several) products from an existing business component would lack the elements discussed above.
Surveys, studies, etc – This category includes efficiency surveys, management – related studies, market research, routine data collection and ordinary or routine quality control.
However, many companies undergo efforts to improve manufacturing processes through continuous improvement, six sigma or other process improvement initiatives. While components of these efforts may fall into this category, others do not and should be tracked in order to assess whether or not the process improvement efforts may qualify for R&D tax credits.
Next week we will review the other four statutory exclusions from qualified research and development.
What say you my friends:
What questions come up when trying to qualify your R&D projects?
What types of triggers do you use to stop the R&D clock when nearing production?
How comfortable are you that you are correctly classifying your R&D projects and costs?
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Randy Eickhoff, CPA is President of Acena Consulting. With more than 20 years of tax and consulting experience, Randy focused on helping companies successfully document and secure tax incentives throughout the US. He has been a long-time speaker nationally as well as conducted numerous training sessions on R&D tax credits and other US tax incentives.
