Research and development (R&D) tax credits can help businesses. But claiming for these credits can be complicated. There are many rules to be aware of, and mistakes can cost money or delay refunds. In this article, we will talk about common mistakes when claiming R&D tax credits. We will explain the rules, and provide some useful tips to avoid problems. This will help you get the credits you should. Let’s start with the first mistake.
Mistake №1: Lack of documents
When claiming R&D tax credits – details matter. Without solid documentation, it won’t be possible to get a successful claim. Here are some common documentation pitfalls:
- Lack of detail on project objectives, activities performed, methodologies used, and results achieved. You should keep records like meeting notes, technical reports, design mockups, and test data.
- Failure to document challenges, uncertainties, and experimentation process. The IRS wants evidence that you went through technological challenges and looked at alternative methods.
- Missing connections between expenses claimed and qualified research activities. Time tracking, payroll registers, and general ledger records can tie claimed costs to eligible R&D work.
- Relying solely on oral testimony rather than written documentation. While employee accounts can back up your case, the IRS prefers contemporaneous written evidence.
- Inadequate document retention policies. Required documentation must be maintained for the credit year plus three additional years in case of an IRS audit.
The key is maintaining diligent, descriptive records throughout the R&D lifecycle from conception through development and testing. Shoddy documentation leaves the door open for the IRS to deny or reduce an otherwise valid R&D claim.
Mistake №2: Trying to claim every cent
R&D tax credits can indeed make big savings for your company, but you should understand that not every expense is eligible. Let’s take a look at what isn’t eligible to claim:
- Marketing expenses: all costs related to marketing, market research, product advertising, and other non-technical selling activities do not qualify as R&D expenditures.
- Routine Operations: you won’t be able to claim expenses on quality control testing, bug fixing, cosmetic changes, and periodic product updates.
- Post-production expenses: costs that were burned after completing the R&D phase like pre production manufacturing facility costs, tooling up for production, and efficiency surveys are usually ineligible.
- Costs outside time period: only expenses paid or incurred during the tax year being claimed (after accounting for potential amendments) count toward the R&D credit calculation.
The R&D tax credit specifically targets the innovative and uncertain components of your development work. Trying to claim routine business costs unrelated to overcoming technical uncertainties through experimentation puts your entire credit at risk. So as a conclusion, analyze each expense and isolate just the qualified research portions.
Mistake 3: Ignoring the requirements
You should understand that not every initiative labelled as “research and development” automatically qualifies for the R&D tax credit. There are some quite specific requirements that need to be met.
The first requirement can be called – qualified purpose. This means that your work must be aimed at developing a new or improved business component like product, process, technique, computer software, etc. General exploratory research without a defined goal does not meet this test.
If the first one is met you can move to checking the second – technological uncertainty. You must demonstrate encountering major technical uncertainties that could not be resolved through readily available knowledge or capabilities. Merely reproducing existing products or using existing methods disqualifies the work.
The third requirement is – the process of experimentation. Overcoming uncertainties requires evaluating multiple alternatives through modeling, simulation, trial and error, or other methods. Keep in mind that routine troubleshooting, simple upgrades, or linear progress do not constitute experimentation.
The final requirement that should be met – technological in nature. The process must rely on hard sciences like engineering, physics, chemistry, computer science, etc. Unfortunately, if your work relies only on social sciences or arts, then you don’t have a chance to have a successful claim.
Mistake 4: Not taking seriously recent legislative changes
The rules for getting tax credits for research and development keep changing over time. New laws can make some expenses eligible that weren’t before, or change the requirements for who can get the credits. If you don’t keep up with these changes, you might accidentally break the rules or miss out on money you could have gotten.
To make sure you understand the latest rules for R&D tax credits we recommend taking the following steps:
- Subscribe to newsletters from professional groups, tax companies, and government agencies. They will tell you about new rule changes.
- Attend webinars and seminars where tax experts explain the new laws and how they impact the credits. Also, don’t be afraid to ask questions about those events.
- Talk to specialists who focus just on R&D tax credits. Their job is to always know the latest rules, so your claims follow them properly.
This should be more than enough to keep you on track with the recent updates.
Mistake 5: Trying to navigate the process on your own
The complexity of R&D tax credit claims can be daunting, especially for businesses unfamiliar with the complex nature of tax law and eligible R&D activities. A common mistake is trying to handle the claim process independently without seeking professional advice. Tax advisors specializing in R&D credits can provide invaluable guidance, helping to maximize your claim, ensure compliance, and reduce the likelihood of errors or audit issues. Their expertise can lead to significant financial benefits and peace of mind.
Final word
Filing for R&D tax credits does not have to be hard. Being aware of common mistakes can help avoid problems. It can make the process smoother. This will help you get all of the credits your business should get. The key is being thorough and informed when you file. Getting help from R&D tax credit experts can also make this easier. They can explain the complicated tax rules.