Both the Internal Revenue Service (IRS) and state Departments of Revenue (DoRs) are happy to give out the research tax credits. However, they also want to make sure that they give out the right amounts. That means checking the filer’s support paperwork to make sure all the numbers make sense.

While this documentation is important, it doesn’t have to be formal (or scary). Taxpayers don’t have to document every single task each staffer has done. It’s important that taxpayers don’t bury themselves in work while compiling strong documentation to support the credit claim against future audit.

Congress outlined the requirements for eligibility with under the Code of Federal Regulations (CFR): “a taxpayer must retain records in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit.” However, it has generally left the details to the IRS and courts to determine. The IRS released audit techniques guide for the research credit that refined this general guideline and provided a framework for what types of documents may be provided. Examples of computation support include:

  • Calculations
  • Chart of accounts
  • Personnel data such as wages paid, included percentage, titles
  • General ledger data
  • Time tracking (if available)

Alternative documentation

The IRS will allow estimation when the documentation is not available. (See Cohan v. Commissioner.) General project data creates the nexus (the IRS’s term for linking) of personnel to projects and costs. This includes any number of documents that illustrate what was done and by whom:

  • External-facing documents such as brochures, press releases, white papers
  • Internal presentation documents for management, board of directors, or review committees
  • Meeting minutes from project meetings
  • Design and development documents including schematics, CAD drawings, notes, and test data

A key takeaway is that while the IRS and DoRs are generally fairly flexible around the specific documents provided – both in type and in name – and that there is no mandatory format, the existence and provision of documentation to illustrate and create nexus is mandatory. (See United States v. McFerrin.) These guidelines provide the framework for computing and substantiating the research tax credit.

Working within your system

A major component of the Hull & Knarr approach is to help our clients work within their existing systems and use available technical documents instead of creating new ones. Many times, the key is to keep copies of the In-Process documents in electronic storage (Some clients send us photos of whiteboards!) or just stop personnel from throwing these away before scanning them.

Contact us to discuss how we can help you document and substantiate your research credit. We will work with you to discover what you have that meets the guidelines and identify easy changes to improve your compliance. While every business is unique, our engineers know exactly where to look to maximize your credit, efficiently.

About: Ariane, Engineering Director, is a degreed electrical engineer and has been with Hull & Knarr since 2006. She lives in Columbus, Indiana, with her husband, 2 kids, and a cat.