Alert

Tax Court Emphasizes Documentation is Required for R&D Tax Credit Eligibility

On April 15, 2019, the United States Tax Court (the Court) ruled in favor of the commissioner in Siemer Milling Company (Siemer Milling) v. Commissioner of Internal Revenue, finding that Siemer Milling lacked sufficient documentation to support the R&D credits claimed. The case is a reminder of the importance of documenting activities giving rise to the R&D tax credit.

Background

In the case, the Court disallowed over $235,000 dollars in R&D credits claimed by Siemer Milling during tax years 2010 and 2011. This disallowance was due in large part to the taxpayer’s failure to retain and provide supporting documentation demonstrating how the company’s activities met all four tests necessary to constitute qualified research expenses.

Siemer Milling claimed that expenses from activities related to development of new flour products and improvements to its production line qualified for the R&D credit. However, the company offered no documentation to demonstrate how the activities constitute experimentation in the scientific sense. The Court found the taxpayer simply stated that it was involved in new product development involving technical activities, but these conclusory statements were insufficient evidence on their own. Simply reciting the steps undertaken was not enough to conclude the company had undertaken a methodical plan involving a series of trials to test a hypothesis to develop new processes or products.

Takeaways

Importance of Reporting

For taxpayers already claiming the credit and those who may want to determine eligibility, this case is a reminder that it’s critical to be thorough when calculating and documenting qualified research activities for R&D credit claims. This is often best achieved with the help of a skilled professional, who can help reduce your company’s risk of facing penalties while helping you capitalize on the opportunities the credit provides.

Other Clarifications

Notwithstanding, this case does provide a couple of taxpayer-friendly facts, with regard to eligibility for qualified research expenditures.  For example, the Court acknowledged that technical uncertainties need not be solved in the credit year but can span more than one year, and rejects the notion that in order for a company to establish it participated in technical activities they must employee individuals with specialized degrees. Additionally, the Court discussed what types of documentation or support of estimates would be useful to properly support credits claimed.  

How the R&D Credit Works

An often underutilized opportunity to reduce a company’s federal income tax burden, the R&D credit offers significant tax savings to those that participate in qualifying research activities by allowing them to include certain expenses directly connected to qualified research in R&D tax credit claims. These may include W-2 wages, supplies, and subcontractor expenses.

Unlike tax deductions, which reduce taxes indirectly by lowering taxable income, the credit offers a direct dollar-for-dollar tax reduction that’s calculated based on a percentage of the qualifying expenses you claim.

Businesses that devote time and resources to any of the following may qualify:

  • Creating new or innovative products or processes
  • Improving existing products
  • Engaging in patent development
  • Developing software
  • Designing and engineering
  • Prototyping, modeling, and trial-and-error testing

We're Here to Help

As this ruling emphasizes, proper documentation is necessary. If you’d like help determining if your business qualifies, pursuing the credit, or have any questions about R&D tax opportunities, please contact us at creditsandincentives@mossadams.com.