R&D Credit - Problems & Solutions documenting Technical Uncertainty

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Posted by Randy Eickhoff on Mar 9, 2012 10:22:00 AM

Acena-can-help-you-document-R&D-tax-creditsLast week we looked at some of the challenges companies face when looking at how to document properly their individual development activities (see Problems & Solutions Documenting R&D Tax Credits (part 1)). This week we will take a brief look at one of the most important tests when evaluating your development activities – Technical Uncertainty.

Let’s take a look:  

The Elimination of Technical Uncertainty Test

As we have discussed in the past, development activities must pass the statutory four-part test given in the Internal Revenue Code and Regulations (under Section 41). In short, the development activity must be undertaken for the purpose of discovering information that is technological in nature.

How do you define information that is technological in nature?

Under the IRC Section 41 Regulations,

 “research is undertaken for the purpose of discovering information if it is intended to eliminate uncertainty…” “Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the business component or the appropriate design of the business component.” (IRC Regulations 1.41-4(a)(3)).

Our key words here are the capability, method or appropriate design.

Simply,

Do we have enough information to know if we can develop the business component (capability)?

Do we have enough information to know how to develop the business component (method)?

Or

Do we know the appropriate design?

Most importantly, are we documenting our unknowns related to capability, method or appropriate design?

Documenting the Uncertainties

Court cases related to R&D tax credits are riddled with testimony regarding why and how a specific business component is documented. In many cases, the documentation was completed many years after the fact through interviews with engineers or business owners. These interviews are sometimes accepted and sometimes rejected by the IRS as valid for the purposes of establishing an activity’s qualification for the R&D tax credit. Factors that are considered include:

How much time has passed since the activity took place?

What was the individual’s role in the activity?

What supporting documentation is available to either corroborate or refute testimony?

How much detail can the individual provide related to the activity?

How can the documentation be completed efficiently?

Depending upon the industry and number of development projects at issue, the ability to properly document technical uncertainty on every business component can be daunting and could outweigh the benefits. For companies that have a limited number of projects (how many is limited depends on individual circumstances), employing a real-time system that allows project managers to input relevant information into the system when a project begins is highly recommended. Additionally, creating a process that provides for efficient input and proper information is critical to successful implementation and use by the R&D team.

While some companies have job cost systems that will track direct labor hours to individual projects, these systems rarely capture project data that would properly satisfy this test unless they are configured properly when implemented. Also, employees engaged in R&D typically are not given proper instruction in terms of what to document and how.

In our next article on Problems and Solutions

Next week, we will be reviewing the issue of documenting the Process of Experimentation that must be identified at the onset of the research activity.

What say you my friends?

Are you currently tracking each research activity separately?

Can you identify the technical uncertainties that exist with each development project?

Have your employees been trained on what to track and document to satisfy the 4-part test for qualified R&D projects?

Other Noteworthy Articles

10 Reasons Not to Take R&D Tax Credits (part 2)

Are all R&D tax credit firms the same?

R&D Tax Credits & AMT

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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.

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