Claiming a Research Tax Credit: Statistical Sampling Approaches

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March 19, 2018

R&D Credits

Claiming a Research Tax Credit: Statistical Sampling Approaches:

Who Can Get Claim a Research Tax Credit (RTC)?

Many people only think that massive companies can claim research tax credits (RTC's), but that couldn't be further from the truth. Today, medium-sized and even small companies can claim research by taking a TRC as long as they fill out the appropriate taxpayer forms1. This is a new benefit the IRS is now allowing as they allow companies to claim multiple years under one statistical sample study. 

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How Have RTC's Worked in the Past?

In the past decades, taxpayers have just used rough estimates to determine how much money and how many resources their research would take. At the end of the year, they would calculate exactly how much the research had cost the company and provide the IRS with documentation to prove that they paid accordingly. After the IRS received an reviewed the documentation they would issue a refund on the company's taxes to them at the end of the year. Statistical samplings are something the IRS has always accepted in a fairly broad manner including domestic manufacturing deductions, tangible property repairs, and cost-segregation studies that companies may have conducted. This relied heavily on estimating costs and then calculating the actual costs as the research is completed.

The IRS would then simply extrapolate a small portion of the entire project and check the costs that the company calculated. That result was the basis on which the company got refunded for the entire project. 

How Can A Company Increase Their R&D?

Many companies are only now beginning to realize (if they have begun to realize at all yet) that medium-to-smaller companies can also increase their R&D expenditures. The business of any size may elect one of two ways to deduct their R&D expenses from their company's income and those two ways include:

  • the option of the regular credit
  • the alternative specified credit (ASC)

Both methods require the qualified research expenditures (QRE's) to be calculated for each tax year to ensure that the expenses add up to what the company is claiming.

For the option of claiming the regular credit2 the following are the steps that are taken:

  1. A fixed base percentage (FBP) is determined based on all of the QREs that were calculated during that period of time and it applies for all receipts dated 1984 through 1988.
  2. The smaller of the FBP or 16% is multiplied by the 4 most recent years' gross receipts, will determine a base amount that is spent the company's R&D.
  3. The excess of any QREs from the base amounts that are calculated will be multiplied by the 20% or 0.20 to come up with the credit that the company receives back.

For company's wanting to claim the alternative specified credit (ASC) credit the following steps are to be taken, which make the ASC credit particularly attractive to more "start-up" level companies by doing the following:

 1(a): Companies whose first tax year of QREs and gross receipts began after 1983.

OR 

 1(b): Companies that have no more than 3 years of back taxes with both their QREs and gross receipts between the period of 1984 and 1988.

2. For the ACS method, the base amount for each credited year is half of the company's average QRE's for the past 3 tax years. Then the amount by which the credit-year QREs exceed the base amount that number is multiplied by 14% or 0.14 to determine the RTC.

This means that when a company determines its QRE it must not just determine it's QRE for not just for that year's credit, but also for a history of the past 3 or 4 years prior to that to give a background of the tax credits that have been applied for the past several years. Remember, the exact history you need of payments will depend upon the method used.

Do I Still Have To Do Provide Annual Estimates?

Yes, the IRS will still require you to provide annual estimates and they will continue to determine the precision of your estimates cumulatively. These estimates still have to be figured out annually. The IRS still considers this tax to be incremental in nature and requires an estimate to be turned in for your R&D activity each year. The IRS also requires that estimates are structured individually for each credit-year so that no references are made to your past year's QREs when you are determining your estimates for that specific year. 

What Documentation Is Required for My Estimates?

There is a 4-part test that must be applied when you are estimating your RTC for the year. Those four steps include the following:

  • Permitted Purposes: Taxpayers must ensure that the activities they are doing fall within the permissible guidelines of the IRS to receive their RTC credits.
  • Technological In Nature: Research activities should somehow relate to the fields and principles of physical sciences, biological sciences, computer sciences, or engineering.
  • Elimination of Uncertainty: Taxpayers must ensure that there are attempts to limit uncertainty to be certain that the project they are undertaking will somehow improvement or development of a currently-developing procedure, process, or product.
  • Processes of Experimentation: The taxpayer must provide reasonable evidence that there is some sort of process for determining if the information found is accurate. Some of the steps to determining the accuracy of the information can include evaluating alternatives, simulations, confirmation of the hypothesis, trial and error experiments, prototyping, or modeling of various ideas or processes that are being used to improve the area of science that the company seeks to improve.

After an activity passes all four tests the taxpayer must demonstrate some connections between the experiments they are conducting and any expenditures that they are claiming to need to deduct off of their taxes. The smaller businesses will find this to be a lot less extensive of a process than the larger company as their experiments and expenses are likely to be on a much smaller scale than a large company's project or experiment would be. 

For more information on claiming an RTC's for your business please feel free to contact us. 

1. https://www.irs.gov/businesses/small-business-and-self-employed-tax-center
2. https://www.irs.gov/businesses/audit-techniques-guide-credit-for-increasing-research-activities-i-e-research-tax-credit-irc-41-table-of-contents

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