As certain as the coming of every new year, enterprises scramble to decrease their tax obligations. These saved dollars safeguard the dreams of expansion, hiring, and pioneership that propel businesses (and the American economy) forward. Yet countless companies investing in research and development (R&D) fail to claim the federal Credit for Increasing Research Activities (i.e., the R&D tax credit) and the similar tax incentives sometimes offered at the state level.

Many business owners are unaware of leaving money on the table. Most work flat out already to keep operations afloat. Substantiating a new tax credit claim feels daunting on an April timeline. It’s critical to qualify R&D activities correctly, document them appropriately, and capture all qualified research expenses (QREs). The untapped cash flow may be empowering and significant. But the fear of the Internal Revenue Service (IRS) looms large.

Acena Consulting preaches proactive documentation as the best tax strategy. In this article, we’ll share some of our tips and tricks for managing qualifying R&D documentation. 

Documentation is Mission Critical

The taxpayer bears the burden of proof when claiming the R&D tax credit, as holds true when filing for most tax incentives. 

Follow these key documentation guidelines to maximize the R&D tax credit amount:

• Capture QREs: 

• • Detailed records substantiate claims and justify the credit amount.

• • Track all relevant expenses, including costs incurred due to employee time spent on qualifying R&D activities (either directly or during supervision), materials, payments to third-party contractors, and supplies. 

• • Maintain records of all employee salaries and wages. This documentation should include year-end Form W-2s, payroll reports, and – for business owners – Schedule K-1s reflecting income affected by self-employment taxes.
• Facilitate accountability: 
  • Organized documentation facilitates a streamlined submission to the IRS, minimizes stress, and prevents delays in the unlikely event of an audit. 
• Keep it current:
  • Proactively gather and document information as expenses are incurred to maintain accuracy and avoid the challenges of reconstructing records later.

Designing a Documentation System

Creating an efficient and seamless documentation system is a critical step that should be taken as early as possible during the tax year.

Any data collection process should:

• Track time employees spent on R&D projects to ensure no QREs are missed.

• • Qualified R&D starts at concept development. Exploratory discussions – be they among clients or internal – should be documented as they can add qualified time.
• Document the entire R&D process.
  • Map the journey from concept inception through commercialization, while keeping in mind that not all activities will qualify. 
  • Describe the purpose, participating personnel, alternatives considered, and activities completed during each step.
  • At least 80 percent of activities should support the Process of Experimentation (PoE).

• Collect information on performed activities to substantiate each project qualification.

• • Activities need not succeed to qualify as R&D, so document successes and failures alike.
  • Always preserve technical drawings. Helpful drawings may include blueprints, change orders, iterations of computer-assisted design (CAD) reports, progress reports, and status updates.
• Prioritize user-friendliness to promote data contemporaneity and completeness. 
  • Keep the system simple and intuitive for employees to use.
  • Remember that compliance starts at the top, so lead by example.

• Lockout data entry after a specified duration (e.g., two weeks) to preserve data integrity.

Overwhelmed or unsure how to proceed? Schedule a free consultation today to receive immediate assistance from Randy Eickhoff, CPA, Acena's Founder & Head Coach.

Stay Informed

Happy New Year from all of us at Acena Consulting! 🎆

Interested in building your professional fluency in R&D tax incentives?

• Sign up for our free, interactive webinar on January 21: “Cracking the (Tax) Code for R&D.”
  • This workshop provides one CPE credit for professionals keeping up with continuing education.
• Subscribe to our newsletter to send industry insights from our experts directly to your inbox.

Reminders

• The deadline for fourth-quarter 2024 estimated tax payments is January 15, 2025. Quarterly taxpayers may pay online via the IRS website.

//

Edited by Randy Eickhoff, CPA, Founder & Head Coach at Acena Consulting. Photo courtesy of U.S. Geological Survey on Flickr.