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R&D Tax Credit: IRS Focuses on Process of Experimentation (POE)

By Michael Silvio, CPA
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When the IRS first came up with the Research and Development (R&D) Tax Credit, the industries it impacted were primarily scientific organizations and lab-based research companies. Today, eligibility has expanded to the point that most businesses in almost every industry can claim the credit, if they are performing research, and importantly, documenting it.

The R&D credit is a valuable tax tool, but it is complex and has attracted the attention of the IRS from the beginning. As recently as July 2021, the IRS made it clear that it was continuing to focus on those claiming the credit especially as it relates to the substantiation of qualified research. But attention from the IRS shouldn’t dissuade eligible businesses from claiming it.

Qualifying for the R&D credit

There are four requirements to qualify for the R&D credit. The business activities must:

  1. Be intended to eliminate technical uncertainty about the development or improvement of a product or process
  2. Constitute a process of experimentation
  3. Be technical in nature and adhere to the standards of hard science
  4. Relate to the development of a new or improved business component

Of all the qualifying requirements, the one that seems to create the most challenges for small businesses is documenting the process of experimentation (POE) in R&D projects.

Product development process

Having a well-documented product development process is just good business practice, but it also makes an IRS audit considerably smoother. If your business follows regulatory or industry standards on how products should be developed and tested, your documentation work is essentially done. However, even without formal industry standards, outlining how products are created, tested, and released will provide the information required by the IRS to demonstrate that you have a formal POE.

Documenting your POE

So, what does the IRS consider proper documentation of your POE? There are a few basic elements that will help make your case to the IRS.
• Project accounting systems that track employee time and project costs provide the level of detail the IRS values.
• Technical project documentation that highlights the process.
• Technical documentation such as design drawings and revisions, patent applications, regulatory submissions, product tracking, and workflow logs.

The best practice for R&D credit documentation is to compile them systematically as you produce them, so you don’t need to search for them later or recreate them. If you clearly define, document, and allocate costs to the specific business components, claiming the tax credit can be a reasonably smooth process.

How we can help

MGO helps organizations across a wide range of industries develop and implement procedures to document their R&D activities. We help clients demonstrate their eligibility for the R&D credit and claim the credit available.

About the author

Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors. He can be reached at msilvio@mgocpa.com.

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