Moving along in our blog series on the eight myths that are costing software and technology government contractors big dollars in annual tax savings, let’s explore our fourth R&D Tax Credit myth (a myth that deals with the actual mechanics of claiming the credit):
Myth 4: I don’t have a system in place to track time or adequate documentation to claim the credit.
Taking into account specific changes over the past few years in how the IRS calculates and qualifies companies for the credit (and how these changes have relaxed the qualifying standards) business owners would be wise not to assume anything when it comes to the R&D Tax Credit.
There are two major changes in particular that have had the impact of dialing back the restrictions with regards to tracking and documentation. One of these occurred in June 2014, when the Department of Treasury and the IRS began to allow businesses to claim the Alternative Simplified Credit (ASC)—a variation of the federal R&D Tax Credit that provides much more flexibility in calculating credit amounts—on their amended returns for prior tax years. The ASC allows businesses to determine their base R&D expenditures at 50% of the average of the three prior years’ expenses, allowing businesses to not have to go back as far in their record-keeping requirements to establish their base as the traditional method requires. As an added bonus, the use of the ASC method often leads to higher credit results as well.
The second big change involving record-keeping requirements revolves around the relatively recent judicial precedent of U.S. v. McFerrin, a ruling that allows for the oral testimony and the institutional knowledge of employees as evidence of research under the R&D Tax Credit. This specific allowance has been of significant help to taxpayers with less-than-perfect-records to still be able to qualify for the credit.
Although the record-keeping requirements have been loosened, companies obviously still need to be able to identify their internal activities and expenditures that count toward R&D to stake their claim for the credit. Doing so often requires not only knowledge of this specific area of the tax code, but how the said laws and guidance apply to each industry. However, considering the potential value on the table—especially for software and technology companies performing work on a contractual basis for the government—getting help from a third party consultant to build out your claim could be extremely lucrative for your business.