Documenting the Process of Experimentation for R&D Tax Credit

By Kenneth H. Bridges, CPA, PFS    July 2019

In order to encourage companies to invest in R&D, and to reward them for doing so, Federal and Georgia tax rules provide what can be very significant tax credits (dollar for dollar reduction in tax liability) for R&D (or for “increasing research activities” to use the actual terminology used in the law).  The rules in this area are very complex, change frequently, and the credits can be subject to a number of limitations, but, in general, from a very high level, the net benefit of the Federal credit is usually about 7.9 cents for each dollar spent on qualifying R&D and the Georgia credit about 10 cents per dollar of qualified expenses. This is in addition to the income tax deduction you get receive for the expenditures, such that the total tax benefit can be up 60 cents on the dollar.

While the credit is often referred to as the “R&D” tax credit, it is important to remember that it is actually a credit for “research and experimentation”, and, as illustrated by a recent Tax Court decision (Siemer Milling), you must be able to document that your expenditures were incurred as part of a process of experimentation.

The term “process of experimentation” means a process involving the evaluation of more than one alternative designed to achieve a result where the means of achieving that result are uncertain at the outset. This may involve developing one or more hypotheses, testing and analyzing those hypotheses (through, for example, modeling or simulation), and refining or discarding the hypotheses as part of a sequential design process to develop the overall component.

The IRS’ recent win in this case could result in the IRS focusing more on the process of experimentation documentation in its examinations of companies claiming the R&D credit.

Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP, an Atlanta-based CPA firm.

This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice.  The article provides only a very general summary of complex rules.  For advice on how these rules may apply to your specific situation, contact a professional tax advisor.