Here is a little secret for you…
The taxing authority may have already drafted your Research Credit disallowance!
In 2008, the IRS published an audit techniques guide that included Exhibit E — Substantiation Write-up Supporting a Notice of Claim Disallowance. This document is currently used by most IRS and state taxing authority teams to support their disallowance of Research Credit claims.
The document concludes: Taxpayer is not entitled to any research credit for Year X because Taxpayer has failed to provide sufficient substantiation to support the amount of its claimed credit.
That’s correct! It is all about documentation….
Taxpayers generate tens of thousands or hundreds of thousands of documents each year. While many of these documents contain a portion of the information needed to document the Research Credit, very few taxpayers generate documents specifically designed for Research Credit substantiation. As a result, most taxpayers need to sift and sort through thousands of documents to find and analyze the sufficient substantiation the IRS requests.
A better approach… provide sufficient substantiation!
What is sufficient substantiation?
The starting point for sufficient substantiation is to gather all the taxpayer documentation related to development projects. This qualitative documentation should include those documents that demonstrate that a research project meets the qualification tests found in the tax code. Ask yourself: if you needed to present a document that showed the technical uncertainties encountered and process of experimentation during a particular project, which document would you present?
A documentation checklist would include, but is not limited to, the following:
- Project files
- Meeting minutes
- Engineering notes
- Technical write-ups
- White papers
- Management reports
The goal… to provide the “economic nexus” between the amount of Research Credit claimed and the activities preformed. Are you ready?