With the end of the NCAA March Madness and another year of fantastic finishes in so many games, we look at the NFL Draft only a few weeks away. Sports, like business requires strategy, focus and tenacity in terms of approach and follow-through. Without exception, we hear the age old saying, “Defense Wins Championships.” When it comes to the research and development tax credit, we believe, this tried and true saying is paramount to long-term success for taxpayers.
Let’s take a look.
Best Case Scenario: Daily Time Tracking By Project
No taxpayer wants to sit across the table from the IRS and defend numbers on their tax return. Even worse, the process can drag out for months or years. When a taxpayer is audited for their R&D tax credit, the key items the IRS requests relate to time spent on individual projects and how the taxpayer developed the numbers. As we have seen throughout many court cases, and most recently in the Shami Court Case (see our blog at Research Tax Credits – Estimates not accepted in Shami Court Case), estimates can be used by taxpayers but must be grounded in credible, verifiable evidence.
Our belief is that developing and implementing a system that tracks the correct information in a format that is easily managed will reduce audit time and result in more favorable audit results.
In other words, a strong defense.
Worst Case Scenario: Self-serving Statements
Another common thread over the various court cases involving the R&D tax credit is the refusal of the IRS to accept taxpayer estimates based entirely on interviews that cannot be verified by other documentation. While the Cohan rule has provided some relief for taxpayers, courts have tempered its use by requiring taxpayers to have some other documentation to show how the estimates were derived and that the estimates used were reasonable.
As it relates to the R&D tax credit, instances were taxpayers have estimated qualified time for themselves; management or other key personnel, without other documentation to give substance to the estimate, the IRS as well as the courts have rejected the taxpayers assertions.
What documentation is acceptable where estimates are used?
It has depended upon the taxpayer and individual situation. Clearly, however, higher wage earners that hold key management positions and estimate higher overall qualified R&D hours are scrutinized more closely than other employees.
The other element that is clear is taxpayers put themselves at risk if estimates used for R&D hours are not based in some other verifiable documentation and should be linked to individual projects. Self-serving statements made by taxpayers (as the IRS likes to call them) without basis are typically not accepted during audit.
Prepare your defensive strategy before it’s needed
Typically, we find that companies don’t know what or how to document the right information. If you don’t know the questions to ask, spending time gathering data for the sake of gathering data isn’t going to result in proper documentation.
Hope, they say, is not a strategy. Make sure your strategy is grounded in credible evidence.
What say you my friends?
Tell us about your R&D documentation strategy. Why do you think it’s best for your company?
How do you track your projects, hours and tasks?
What if you had a system that took less than 60 seconds a day to document the necessary information? Would that be worth investigating?
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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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