R&D Tax Credit Documentation is Critical

by Erin Carmody January 06, 2012

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As I emphasized in an earlier post, the R&D Tax Credit represents an excellent opportunity for companies that make investments to improve their business, yet many remain unaware of the fact that they could qualify. When claiming the credit, however, it important to bear in mind that proper documentation of related costs is of utmost importance. The IRS has designated R&D costs a Tier 1 audit issue. This designation essentially means that if your company is audited, the R&D tax credit issue will without a doubt be raised. While this shouldn’t deter companies from pursuing the credit, it does send a clear message regarding the Service’s intention to keep a closer eye on this reporting category.

In addition to the credit’s Tier 1 status, other factors necessitate thorough documentation, including a recent change affecting Schedule M-3 disclosures. Companies that are required to file Schedule M-3, Net Income (Loss) Reconciliation, are now further required to report their R&D costs in this filing, and to reconcile any difference in timing recognition for financial and tax purposes. If you’re an M-3 filer, you won’t have to attach a separate supporting document to the M-3 for 2011, but you will need to have your supporting documentation on hand so that you’re prepared in the event of a future audit. In later reporting years, a supporting attachment will likely be mandatory.

If your company is audited, cleaner records and organized supporting documents will make things much easier for the auditors and for your staff. Taking the time to document everything now will lead to less questions and a less frustrating audit process later. One of the major items you’ll want to track closely is employee time; auditors will be looking for timesheets that clearly attribute employees’ work hours to research activities. Given the depth of information you will be responsible for maintaining, if you are claiming and utilizing credits, it might be a good idea for your company to bring in a third party for an objective R&D tax credit study.

For a general overview of the R&D Tax Credit and what it applies to, be sure to check out my September 7, 2011 post, You Might Qualify for the R&D Tax Credit – Yes, You. I would love to answer any questions you may have about the credit, so feel free to contact me or to voice your inquiry in the comment box below.

Material Discussed in this MFA Business Insights Blog is meant to provide general information and should not be acted on without obtaining professional advice tailored to your firm's individual and specific needs. This information is for general guidance only and is not a substitute for professional advice.

IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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Erin Carmody
Senior Tax Manager
(978) 557-5328
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