How to Make Your R&D Tax Credit Defensible

1. Understand Which Activities are Considered Qualified Research Activities

One of the most important things you can do to make your R&D tax credit defensible is understand what qualifies as research activities. Qualified research activities are specific efforts to develop new products, fabrication processes, or software, or improve existing ones. This can include activities such as developing firmware and risk management systems, designing tools and fixtures, automating manufacturing processes, and much more. 

To determine if your research activities are eligible under the R&D tax credit claim, you’ll need to ensure each passes the Four-Part Test as outlined in IRC §41(d). Any company that wants to claim the R&D tax credit must satisfy each of the criteria of the Four-Part Test, including the Business Component Test, Technological Uncertainty Test, Process-of-Experimentation Test, and Technological-in-Nature Test. Learn more about the Four-Part Test here.

2. Make Sure You Meet the Additional Qualifications

In order for a taxpayer to claim the R&D tax credit, there are a few minimum qualifications that must be met in addition to the above-mentioned qualified research activities. These additional requirements include having 5 years or less in revenue and having less than $5 million in revenue in the current year. It’s important to note that qualifications can vary by state, so you’ll need to understand these specific qualifying factors within your state when claiming the tax credit.

3. Maintain Detailed Records

By keeping detailed, accurate records of any R&D activities, you’ll increase your chances of being able to support an R&D claim. Records should include gross receipts, invoices (including subcontractors), payroll records, employee information, and detailed project descriptions.

4. Stay Updated on Current Changes

The R&D tax credit program periodically changes, making it critical to stay informed of any changes in deadlines, qualifications, document requirements, and many other items. For example, significant changes have been put into effect as of the beginning of 2022 related to §174 R&E. Specifically, taxpayers that have R&E expenditures or software development costs must now amortize the costs over 5 years. The costs can no longer be deducted in the year period or incurred. Claiming the R&D tax credit could potentially offset some of the tax resulting from the amortization of Section 174.

5. Consult with an R&D Tax Professional

Claiming the R&D tax credit can be complicated. Tax professionals who specialize in R&D tax credits can help ensure your claim is accurate, identify your qualifying development activities and expenses, compute your R&D tax credits, prepare supporting documents that are needed, and assist with other tasks (including providing audit support).