Tips to Secure R&D Tax Credits: Court Ruling Emphasizes Documentation and More

Thorough documentation and reliable expertise are crucial when claiming R&D tax credits.

In Betz v. Commissioner, T.C. Memo 2023-84, the United States Tax Court rejected a taxpayer’s R&D credit, reiterating specific areas businesses should focus on during the claims process.

Explore key considerations related to R&D tax credit claims below.

Court Case Overview

The taxpayers in Betz were shareholders in Catalytic Products International, Inc. (CPI), an S corporation. CPI designs and supplies air pollution control systems based on customer specifications.

For tax year 2014, CPI claimed a research credit of $501,531 that was passed-through to the shareholders on their respective Schedules K-1. In July 2018, the IRS issued to each shareholder a notice of deficiency for the research credits claimed on their personal returns and accuracy-related penalties under Internal Revenue Code (IRC) Section 6662. Consequently, the taxpayers petitioned the court.

The court assessed all 19 projects for which CPI claimed the 2014 research credit. In summary, the court held that:

  • For all 19 projects, the taxpayers failed to carry their burden of establishing that the products were pilot models. Thus, such costs for production weren’t creditable.
  • For all 19 projects, the taxpayers failed to carry their burden of establishing that the wages of certain employees were incurred for qualified services. Thus, such wages weren’t creditable.
  • For five of the projects, the taxpayer didn’t retain substantial rights in the results of the research. Thus, costs for such projects weren’t creditable.

The court also held that the taxpayers were liable for accuracy-related penalties under IRC Section 6662.

Tips to Help Sustain R&D Tax Credit Claims

Enhance your chances of sustaining claimed tax credits by performing these tasks during the claims process.

Provide Detailed and Substantiated Evidence

Per regulations, a taxpayer claiming a credit under IRC Section 41 must retain records in a sufficiently usable form and provide detail to substantiate the expenditures claimed are eligible for the credit.

In Betz, the taxpayers largely relied on trial testimony for substantiation; the court found that such testimony, at times, was “vague, in conflict with the record, and lacking in credibility with respect to their self-serving characterizations of some of the work performed by CPI on specific projects.”

Businesses must have robust evidence to support their claims. Documentation and testimony should clearly outline the nature of the research activities performed, employees involved, and time spent on qualified research activities.

Document Methodical Plans and Experimentation Processes

Businesses must demonstrate that a process of experimentation and methodical plan was used in the R&D. Clear records that outline the investigative activities undertaken and the systematic nature of research must be maintained. In Betz, the court repeatedly determined investigative activities weren’t conducted during the tax year that would constitute research and development.

Keep detailed records of all research activities, including:

  • Purpose of the research
  • Methods used
  • Results obtained and subsequent design iterations based on testing result
  • Time spent on each activity

Also document the activities and qualifications of the individuals who conducted the research, including their education, training, and experience.

Retain Substantial Rights

A key requirement for claiming the R&D tax credit is ensuring the business maintains substantial rights in the research. Importantly, incidental benefits to the taxpayer from performance of the research, such as increased experience in a field of research, don’t constitute substantial rights in the research.

In Betz, the court closely examined the terms of the contracts between the taxpayer and its clients, focusing on whether the taxpayer retained substantial rights in the research. This analysis should be conducted as part of the R&D credit claims process.

Seek Reliable and Credible Expertise

Businesses should carefully select tax preparers or consultants who have a deep understanding of the R&D tax credit rules and regulations.

Thoroughly vetting and engaging experienced professionals can help ensure accurate and well-supported claims.

Avoid Negligence and Penalties

In Betz, the court held that the taxpayers were negligent with respect to their underpayments of tax, failing to maintain adequate records substantiating their entitlement to the research credits. Accordingly, accuracy-related penalties were assessed to the taxpayers.

To avoid penalties, businesses should exercise due diligence, maintain proper documentation, and seek professional guidance.

We’re Here to Help

For more information on how to successfully claim R&D tax credits, contact your Moss Adams professional.

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