The R & D Tax Credit or research credit has been on and off the books since 1981. Many small companies complain that they are rigorously audited while large companies tend to breeze through the process. Most arguments countering the point involve the fact that large corporations keep more scrupulous books and can afford a more detailed tax professional. However, small companies is the majority of growth in the United States and them working through the tangles of the R & D tax credit can really speed up their progress on unfolding new processes or products. Here are a few of the sticky points small businesses get held up on.
Ease of Use
On the IRS.gov site it specifically mentions to auditors that the questionnaire sent in must specifically point the auditor to the correct paperwork. You can’t assume that a giant binder of information and a filled in questionnaire will be enough to make the tax man feel good. They want to verify your information and they don’t want to spend a lot of time doing it. If it’s difficult to track down your information they may deny you there.
The Base Period
Part of the application for a R & D tax credit is the submission of research and development costs over a three year baseline prior to the application. The government wants to see that the R & D project was special and above normal operating expenses. If you can’t prove the project was significantly above your normal expenses or you don’t have three years of history you’ll probably be denied, though there are some complicated alternatives to a base period.
It has been submitted that a company sampled its expenses and found that 10% of all cost went to the R & D department so 10% of the whole budget was submitted for the tax credit. This is not allowed. Every dollar must be proved unless you use a professional statistical model for sampling and validation. If you’re a small company you’re far ahead to just validate every dollar than explain your sampling to a judge.
This credit is one area where your accounting books aren’t the only part of your business being audited. Often an IRS engineer will review your project data to validate that the expenses are in line with the scope of the project. Here are some questions for auditors right from IRS.gov
* all or part of the activities undertaken in the cost center did not involve qualified research activities;
* all or part of the expenses claimed in the cost center as QREs were not qualified expenses;
* the taxpayer’s sole basis for substantiating the qualified activities of the cost center was estimates; or
* the basis for allocating qualified or non-qualified activities or expenses is arbitrary or there is insufficient corroborative evidence to support the allocation.
Obviously this R & D tax credit is a complicated beast and should not be for the faint of heart. Have a tax professional and make sure your project justifies the expense of extra record keeping and audit defense.