One of the main reasons businesses today do not claim the Research and Development (R&D) Tax Credit is due to a lack of understanding regarding what exactly needs to be documented as well as submitted in order to receive it. Thankfully, here at Acena Consulting, we are dedicated to helping businesses like yours find the right documentation to claim and benefit from the R&D Tax Credit.
This helpful checklist should help you to better understand what is required for submission.
Checklist Item #1: Documents to be submitted
The R&D scope includes the framework of items that makes your business eligible to claim an R&D credit. These documentation items include:
- Form 6765: This form must be attached to the tax return. It must be completed properly in accordance with the instructions.
- Research Credit Claims: This is documentation of an overpayment of tax for the tax year being generated (part or whole) by the R&D credit but was not taken into account with the original return. If this has happened, a claim may be filed on an amended return with Form 1120X or 1139, depending on the situation. The actual calculation of the R&D credit must still be submitted on Form 6765 which will provide the detail and calculation for the credit.
- Computation Work Papers: While the work papers need not be submitted, these include the research credit computation work papers for the years the claim is being filed. This should include the reconciled amounts on the taxpayers from Form 6765. Also include current year Qualified Research Expenses (QREs) including the wage reports, supplies, and research expenses. Lastly, if the business has other entities that meet the definition of a Controlled Group, (i.e., under common control within section 41(f)(1)(B)) they must perform additional calculations and include information from all entities (regardless of whether the other entities have qualified R&D activities), add additional disclosures that are attached to Form 6765 and should supply all members with detailed information and receipts.
Checklist Item #2: Research Credit Computation
Conducting a review of any mechanical computation in the R&D credit is a key point in the examination process. All required documentation should be available (in the event of an audit) to determine how the taxpayer has properly calculated the credit for the year being submitted. In the event any estimates were used in the computation, documentation as to how the estimate was developed is important to have available.
Checklist Item #3: The Qualified Research Expenditures (“QREs”)
QREs include the sum of your in-house and contract research expenses. These include:
- Wages: This includes any payment to an employee for the qualified services that were performed.
- Supplies: The payment made for any necessary supplies being used during the qualified research activities.
- Contract Research Expenses: The amounts paid to an outside party for conducting qualified research activities.
Checklist Item #4: Qualified Research Activities
Taxpayers must also show evidence of how and why the qualified research activities qualify through a four-part test:
1. Business Component Test: Are the research activities being conducted to develop or improve on a business component?
2. Discovering Technological Information Test: Do the research activities eliminate technical uncertainties discovered at the beginning or during the research process?
3. Process of Experimentation Test: Is there a process of experimentation conducted that evaluates alternatives or utilizes scientific method to alleviate technical uncertainties?
4. Use of Scientific Principles Is the Process of Experimentation based in the principles of the hard sciences?
To be eligible to receive the credit, taxpayers must be able to provide documentation of the activities they are performing that meet the requirements of all 4 of the above tests.
Note: For internal use software, taxpayers must also meet the High Threshold of Innovation test.
Checklist Item #5: The Consistency Requirement
The Consistency Requirement requires that for purposes of calculating the fixed-base percentage, the QREs of the credit year, as well as the QREs of the base years are developed on a consistent basis.
The Consistency Requirement attempts to ensure consistency in comparing qualified research expenses in the past are developed in the same way as the current year. This requirement also helps provide proof that there’s been a rise in the qualified research expenses as a percentage of gross receipts, relative to the base period. Base year expenses must be documented and can be an area of concern if the taxpayer must use the 1984-88 method for calculating the fixed base percentage.
Checklist Item #6: Audit Documentation
The IRS requires taxpayers to retain records in a usable format to detail and identify how the expenditures being claimed provide credit eligibility. Documentation to keep available for possible Internal Document Request (IDR) include:
- Fixed base percentage calculations including the base amount
- Organizational charts
- Chart of Accounts for the general ledger
- Dispositions or Acquisitions of businesses or lines of business within a company that occurred from 1984 to the tax year being audited
- The accounting process or methods used by a department or project
- Any R&D documentation activities conducted as well as a description of why they are eligible activities.
- The wages paid, employee or contractor names, percentages of time allocated to qualified R&D activities, departments involved in the R&D activities, and the names, job titles and job descriptions of all research participants.
- Lists and descriptions of all supplies used on qualified projects including which project they were used on, categories they fall into, as well as how they paid.
- Copies of all contracts with outside vendors or service providers as well as the amounts paid, location of research conducted and the categories of work performed.
At Acena Consulting, we understand what documentation is necessary to substantiate your claim for an R&D credit. We love helping businesses like yours navigate through piles of paperwork so they can leverage the tax credit benefits that are available to them. Contact us today to see how we can help you construct your R&D tax claim.
For more information on R&D credits, download our free eBook below. Or calculate your estimated R&D tax credits with our R&D calculator.