Garbage In – Garbage Out
One of the key elements of getting good quality information from employees involved in the R&D process is education and training. Otherwise, the information they are collecting may not answer the questions being asked for a project to qualify for R&D tax credits.
What do your employees need to know?
The Business Component Test – Simply put, the first test a development activity must pass is determining whether or not it is the development or improvement of a product, process, software, technique, formula or invention. Typically, I ask my clients to document, in plain English, what is it they are doing or building or improving; a simple project description.
Technical Uncertainty – In order for a project (or development effort) to qualify, there must be some technical uncertainty at the onset of the project. What is technical uncertainty? Technical uncertainty exists if the information available to the taxpayer does not establish the Capability, Method or Appropriate Design of the business component. I ask my clients to document what it is they don’t know about getting the project to a point where they can manufacture it. Are there iterations of the design? Why did it take six months to go from concept to manufacturing? Where were the failures or bottlenecks along the way?
Process of Experimentation – The Internal Revenue Code defines the Process of Experimentation as a process to evaluate more than one alternative designed to achieve a result where the capability or method of achieving a result is uncertain at the onset (sound familiar?). In plain English, how are we eliminating the uncertainties we identified at the beginning of the development effort. I ask my clients to document the alternatives considered or attempted and their process for evaluating each (including how-computer modeling, additional research, trials, prototypes or various trial and error processes). Keep in mind that this evaluation process applies to not only product development or improvement but process, software, techniques, formulas or inventions.
Scientific Principles – The final test or hurdle a development activity must pass is typically the easiest. The Process of Experimentation defined in our third test must rely on the principles of biological, engineering or computer science. Typically, these sciences are inherent in the process of experimentation and could not be completed without them. During our quarterly or year-end study process, we will document during our interviews, the sciences that apply to each process.
While the above tests may seem to some people as a lot of documentation, when a process is put into place, it can be relatively easy and painless once implemented. Our clients use a number of different ways to implement the above documentation standards that fit best with their internal culture and processes.
Randy Eickhoff, CPA is President of Acena Consulting. With more than 20 years of tax and consulting experience, Acena Consulting 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.