R&D tax credits: How to navigate the claims process step by step

The R&D tax credit can provide reliable opportunities for businesses to reduce income tax liabilities — often saving companies hundreds of thousands of dollars.

Many companies, however, don’t take advantage of the R&D tax credit because of common misconceptions that cause them to assume they’re not eligible or that it’s an overly complicated process not worth pursuing.

Below we outline eligibility requirements for businesses and how you can confidently navigate the claims process.

Overview: What is the R&D tax credit?

The R&D tax credit is available to businesses that develop new or improved products or processes that result in a new or improved function, performance, reliability, or quality.

Tax refunds can exceed 10% of annual R&D costs for federal credits and even higher when applying state-level credits.

R&D tax credit four-part test

To be eligible for the credit, R&D activities must meet IRS criteria known as the four-part test to:

• Demonstrate you’ve attempted to eliminate uncertainty about the development
• Establish you underwent a process capable of evaluating alternatives
• Prove your experimentation relies on science
• Demonstrate the research intended to create a new or improved business component

What happens during the R&D tax credits claims process?

Completing the steps to pass the four-part test may sound overwhelming and can drain precious time and resources should your business pursue it on your own. Claiming credits incorrectly can also result in the loss of credit and possibly penalties from the IRS.

Seeking guidance from an experienced tax professional, however, can help streamline the process so you submit claims with thorough documentation covering all areas of concern.

Collaborating closely with your team, our professionals can guide you through the following steps.

What documentation is required to claim the R&D tax credit?

It’s important for companies to have the right documentation in place, noting that there isn’t a one-size-fits-all approach to documentation.

The adequate level of documentation varies based on the size and scope of the claimed credit amounts.

Companies should expect a greater time commitment in the first year when they’re getting set up to claim an R&D tax credit. They’ll also need to put appropriate measures in place to completely use the credit going forward. Depending on the company, historic R&D spending incurred may need to be evaluated.

Proving nexus

Taxpayers often will need to provide a nexus between their R&D expenses and qualified research activities. This can be challenging — even for companies that have some level of project tracking in place–because time-and-expense tracking systems aren’t generally intended to track eligible R&D expense to business components or R&D activities.

The subjectivity and interpretation of R&D rules make it difficult to develop the perfect software tool for tracking eligible expenses and documentation, particularly when considering annual updates to tax law, regulations, and IRS guidance.

Note that while project-accounting and time-tracking systems aren’t prerequisites to claiming the R&D credit, implementing them can supply important insight into your company’s activities.

Meeting the four-part test

Taxpayer qualitative documentation should demonstrate how their underlying activities meet the four-part test. Examples of adequate documentation can vary by industry, but it’s possible for companies to leverage documentation they generate in their day-to-day operations.

Qualitative documentation may also require review and analysis of any contracts between companies and their customers, partners, or vendors.

Taxpayers that have some level of familiarity with the R&D credit should carefully evaluate their methodology and documentation standards with respect to R&D credits being used under the new rules.