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Numerous enterprises were left scrambling for new sources of funding as a result of the COVID crisis, prompting many to consider R&D tax credits for the first time, and you can get a reliable computation by utilizing an R&D tax credit software.
Since not every new procedure or method of issue solving counts for an R&D credit, firms that shifted their focus during the epidemic may qualify for these critical tax breaks, and no one wants to miss out on money. Therefore, businesses should make use of all available innovation incentives.
Nonetheless, the R&D tax credit structure is complex, and in their haste to obtain capital, some organizations cut shortcuts, received inadequate counsel, or just made poor choices. Now that the IRS is paying greater attention — including putting R&D credit fraud to their list of “dirty dozen” tax frauds — many firms that made errors or bad decisions when claiming R&D credits may soon face an unpleasant repercussion.
With newly modified R&D credit audit requirements for software development, firms must now pass strict eligibility tests in addition to current laws requiring taxpayers to preserve concurrent technical and financial evidence for all R&D activity for which they wish to claim a credit. Businesses that file claims without doing enough technical as well as financial due diligence may encounter significant issues in the future when interacting with the IRS.
Wagering that you will escape an audit is never a good idea, but with the federal government now taking enforcement seriously, now is an especially awful moment to attempt. While you cannot completely eliminate the danger of an audit, these are the most critical steps you can take to prevent raising red flags — or being hurt if the tax authority does choose to look more closely at your books.
Recognize What Constitutes as Research
Ascertain that all R&D credit claims meet the IRS’s four-part standard and actually qualify as “qualified research,” which means that it is “substantially all of the research activities” and must have been directed toward developing new or improving existing functionality, performance, reliability, or reliability of a business component like a product, procedure, methodology, innovation, formula, or computer software that you are planning to hold for your company either for sale, rent, licensing, or actual.
Additionally, you must go through a methodical, scientific “process of experimentation” to resolve a technologically unknown issue. You cannot just conjure up a concept and claim innovation; you must do thorough research to back up your claim.
Simultaneously, it is critical to understand what does not qualify as research because the R&D tax credits are not available for studies, surveys, international research, grant-funded R&D, reverse engineering of other businesses’ technology, or post-production research. The R&D credit is intended to encourage innovation in the United States that results in tangible benefits; therefore, anything that involves work performed outside the country or that does not clearly and directly result in a genuinely new or improved product or process is expressly excluded from the credit.
Recognize Variability and the ‘Experimentation Process’
Risk and uncertainty are considered to be inherent in the experimental process that underpins R&D. According to the IRS, “uncertainty occurs if the taxpayer’s information does not demonstrate the product’s potential for development or improvement, the technique for creating or enhancing the product, or the product’s proper design.”
Additionally, the IRS cautions that “merely establishing that ambiguity has been removed is inadequate.” This implies that you must engage in an experimenting procedure. If you can readily identify methods to manage uncertainty without engaging in an experimenting phase, you are just producing something — but it does not qualify for the R&D credit.
This is a relatively ambiguous issue for software developers: Whereas the risky creative effort associated with designing new software undoubtedly qualifies, the more routine risks associated with configuring a piece of software to function in a certain environment do not qualify as claimable R&D activities, and neither would the inherent risks of the business. While you may not know if customers will respond positively to your product or whether personnel can be trained to use it efficiently, these uncertainties are insufficient to be eligible for an R&D credit. Section 1.41-4(a)(5) of the Code of Federal Regulations provides the definition of what an experimentation process is, and this must fundamentally be based on physical or biological sciences, engineering, or computer science principles, and this must also include identifying unpredictability, the identification of one or more alternatives to eliminate that degree of uncertainty, as well as the identification and conduct of a process of evaluating the substitutes.
Keep a record of everything
The best way to survive an audit is to maintain accurate records — and to ensure that each dollar claimed can be appropriately accounted for. The goal is to guarantee that your R&D research is founded on substantial, contemporaneous evidence that explains the work performed and the outcomes obtained. This necessitates the preparation of accurate records by someone who is knowledgeable in their field. The IRS often rejects reports that are either basic boilerplate or fail to adequately define and record the finished study. Consider this throughout your study, not only when it comes time to request a credit. Retroactively filling in the spaces is a formula for catastrophe.
It is obvious that the COVID epidemic has wreaked havoc on the tax system. Consider the IRS’s inability to process submitted forms or its choice to extend the deadline for filing individual tax returns by a month. In the midst of the mayhem, it may appear as though a bad R&D tax credit claim will just be pushed under the rug. Although the IRS is now befuddled, the papers you submit when claiming an R&D tax credit will stay on file for coming years. When the dust settles, several corporations who submitted erroneous R&D credit claims will be revealed.
This is not to say that you should forego any available tax credits because many small companies are eligible for up to $250,000 in research incentives. It’s essential completing your research and ensure that you’re not losing out on a benefit that may help your firm continue to develop during these trying times. However, avoid taking shortcuts and assuming you can manage the complexity of the R&D incentive scheme without expert support.
You may also like: Major R&D Tax Credit Changes Coming in 2022
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