Each year, the Internal Revenue Services publishes the “Dirty Dozen,” a list of scams and tax schemes that the agency focuses on. This year, the IRS has put the abuse of business tax credits in its sights.
âInappropriate claims for research and experimentation credit typically involve failures to participate in or justify qualified research activities and / or meet requirements for qualified research expenses,â the IRS said.
Why did the research and experimentation credit, better known as the R&D credit, end up on the âDirty Dozenâ list? In 2017, the Inspector General’s Treasury Office reviewed R&D tax credit claims worth $ 53.8 million. In total, $ 11.8 million in credits were deemed potentially erroneous, or 21% of all R&D tax credit claims. Some complaints were filed inappropriately. Some did not meet all the requirements for appropriate claims or did not attach the appropriate documentation.
How does the R&D credit work? What can taxpayers do to make sure their returns are correct?
The R&D tax credit was created in 1981 to encourage companies to invest in innovation and stimulate research and development in the United States. The R&D credit applies to any company that devotes time and money to the development of new products; improves the products or processes or software it uses in manufacturing; creates patents or prototypes; or hiring researchers, scientists and designers.
The R&D tax credit provides dollar-for-dollar compensation for federal income tax as well as payroll tax in certain circumstances. Additionally, many states also offer similar R&D tax credits. Between federal and state credits, the average potential credit benefit could range from 10% to 20% of eligible expenses.
The R&D credit is calculated on the basis of the totals of two different types of research expenditure: qualified research expenditure (QRE) and basic research expenditure (BRP). ERQs and BRPs relate to activities that advance American technology and are performed in the United States
ERQs should be used for specific business purposes, but should not advance scientific knowledge. QRE can be used for improvements or developments of processes, products or software. To be eligible for the QRE R&D tax credit, activities must meet each element of a four-part test – qualified objective, technological uncertainty, process of experimentation, and technological nature.
Examples of activities that are excluded and are not eligible for R&D credits include research conducted outside the United States, routine data collection or routine testing for the quality control of existing components, market research, management, consumer preference testing and research funded by an unrelated third party.
Examples of activities that are not eligible because they fail the four-part test include: administration, training, repairs and maintenance, production testing, troubleshooting, and duplication of an existing component. by reverse engineering.
BRPs differ from ERQs in that they are used to obtain scientific knowledge without having a specific purpose. Under IRC Section 41 (a) (2), BRPs must be conducted in the United States by qualified organizations and cannot involve social science, humanities, or artistic research.
If you’re a small business owner or manager, you know what it is. You try to deliver the most efficient processes and innovative products, but stopping to reconsider what your business has done takes time, people, and money. It gives big companies an unfair advantage. They have more people, which means they can create more efficiency and still grow.
R&D tax credits allow small businesses to invest in research. Even companies with little or no R&D departments could benefit from the credits. Indeed, most taxpayers who benefit from R&D credits do not have explicitly named R&D departments. Additionally, you may be eligible for R&D credits regardless of whether your activities are successful or not.
A taxpayer claiming an R&D credit must maintain records in a sufficiently usable form and detail to justify that the expenses and activities claimed qualify for the credit and are not inappropriate. Abusive claims can happen in a number of ways, but the best way to avoid them is to have your claim thoroughly reviewed by a tax professional you trust. Remember: the lowest possible tax bill isn’t the only goal. Precision is also important.