As the year comes to a close, you might be thinking about ways to minimize your 2024 tax bill. At any tech company, that means exploring how to maximize your R&D tax credit. Technically called the “Credit for Increasing Research Activities,” this tax savings opportunity can help companies get as much as $500,000 back.
This is an area you don’t want to miss out on. But recent news has underscored the importance of taking the requirements for claiming this tax credit seriously.
What we learned in 2024: takeaways from the Kyocera case
Like any tax savings opportunity, the IRS wants to see proof that your company qualifies for this tax credit. That means proving the money you’ve spent on qualifying research activities.
In some cases, this is fairly easy. If you buy a piece of equipment for research purposes and you save the receipt, you’ve got the documentation you need.
But because salaries count as a qualifying expense when that individual is specifically undertaking qualifying research, the water can get muddy. You then need to prove the amount of that individual’s time that was focused on your qualifying research activities. And a recent court case proved that the IRS can get pretty granular here.
Specifically, the U.S. government is arguing that the multinational firm Kyocera can’t claim this credit and the resulting refund because “it failed to create or retain the documents required to substantiate its entitlement to the credit.”
Kyocera wasn’t loose in how they attempted to substantiate their claim to the credit. Court documents show that the company initiated a study with a Big Four accounting firm to determine the size of their credit. The accounting firm then conducted staff interviews as part of that study. In short, the team involved had extensive experience in this tax credit and made a concerted effort to substantiate Kyocera’s claim. Still, the IRS wasn’t satisfied.
Big takeaways from this situation
For any company interested in claiming the R&D tax credit, the most notable thing to learn here is that the IRS requires substantiating documentation. Word of mouth — even in a formal setting like an interview conducted by an accounting firm — isn’t enough. The paperwork is critical.
That’s where Kyocera and its accounting partner got into trouble. The electronics company didn’t retain (and potentially didn’t ever create) substantiating documentation. Then, its accounting partner didn’t keep records from the study it conducted to determine the size of Kyocera’s tax credit.
As a result, when the IRS looked into the claimed credit, it found little to back it up. This was particularly problematic because a big part of the credit claim was predicated on employee salaries. Without proof that those employees were actually working on the qualifying research activities for the duration the company said, the IRS has grounds to refuse the credit.
That’s likely going to hurt Kyocera to the tune of $398,985 (the size of the credit it attempted to claim).
Documenting qualifying research activities is the big takeaway here. But there’s another lesson to learn from these court proceedings. The U.S. government is arguing that Kyocera can’t satisfy the credit’s four-part test requirement. Specifically, the court case argues that the tech company fails part four of the test, which requires that “substantially all” of its expenditures on the projects for which it’s claiming the credit involve a process of experimentation.
So, what does this mean for other tech companies hoping to claim the R&D credit in 2024? Two things. First, documentation is paramount. Secondly, you need to understand the four-part test to ensure your company’s passing it. Let’s look at both.
Solving the documentation issue
In order to successfully claim this tax credit, your company needs to be prepared to prove that any expenses you apply toward the credit were, in fact, research-focused. As we mentioned earlier, that’s often the most challenging when it comes to applying salaries and wages toward your claimed total.
Here, contemporaneous documentation goes a long way. Any project plans you have stored in your project management tool (e.g., Jira, Asana) can provide proof to the IRS that your team was, in fact, engaged in research activities.
From there, it can be a big help to have people track their time dedicated to the research activity in real-time. This is true even for salaried employees. Having them log the hours they apply specifically toward the research activity gives you a solid foundation on which to claim the credit.
Satisfying the four-part test
Per the part of the Internal Revenue Code that talks about this tax credit, to qualify as research, the activity needs to:
- Be undertaken for the purpose of discovering information
- Be technological in nature
- Be intended to be applied to develop a new or improved business component
- Use a process of experimentation
That last bit is what got Kyocera into trouble, so let’s break that down a little further. If substantially all of the research activity uses a process of experimentation, it means that your team has:
- Identified the uncertainty regarding the business component (i.e., trying to discover new information)
- Identified one or more alternatives to eliminate that uncertainty
- Identified and conducted a hard science-based process for evaluating those alternatives
We have a guide to the four-part test to help you better understand these very specific requirements. They can get pretty technical, so it’s well worth sitting down with your accountant to determine which research activities can qualify.
Help with maximizing your R&D tax credit
If you want to dedicate a little more time to exploring this tax-saving opportunity, we have a comprehensive guide. It’s designed for tech company founders, but the information in it applies to any company hoping to claim this tax credit.
Additionally, we recommend reading our blog on some notable changes to this credit in the last couple of years. Specifically, you now need to capitalize and amortize your research expenditures instead of claiming them in full in the year in which they’re incurred.
Obviously, claiming this tax credit is by no means simple. But because it represents such huge savings potential, it’s well worth exploring for the vast majority of tech companies. That’s where we come in.
As experts in this credit and all of its requirements, our team can help you identify qualifying research opportunities, properly document the expenses attached to them, and file the necessary paperwork to claim the maximum credit. Get in touch with us today to get started.
